Hiring an independent contractor or freelancer can be one of the smartest ways to grow your business without taking on the expense of a full-time employee. But don't assume every worker qualifies as an independent contractor. If you get it wrong, you could face IRS penalties, state labor issues, lawsuits, and unexpected liability.
The good news is that hiring contractors doesn't have to be complicated. Follow the right process from the beginning, and you'll protect both your business and the people you hire.
Employee vs. Contractor
Before hiring anyone as an independent contractor, make sure they truly qualify. The IRS looks at factors such as behavioral control, financial control, and the overall relationship between the parties when determining whether a worker is an employee or an independent contractor.
Here's my simple rule of thumb: if they act like an employee, work like an employee, and are paid like an employee, they're probably an employee.
If you incorrectly classify a worker as an independent contractor when they should be an employee, your business, and potentially you personally, could be liable for accidents, injuries, property damage, or other claims involving that worker. On top of that, the IRS and your state tax agency may assess back payroll taxes, penalties, and interest because you failed to withhold and remit employment taxes.
If you're unsure where someone falls, take the time to get it right before you hire them. It's much easier than fixing the problem after an audit.
Screening and Hiring an Independent Contractor
There are plenty of honest, reputable contractors who understand their role as independent business owners. In fact, many insist on doing things the right way because it protects them too.
However, you still need a process for hiring, documenting, and reporting your contractor relationships. Here's the checklist I recommend.
- Get more than one (1) quote.
Ethical contractors understand you're likely getting multiple bids. This gives you the opportunity to compare pricing, ask questions, evaluate professionalism, and determine who you feel comfortable working with. A contractor who cuts corners in running their own business may cut corners on your project as well.
- Do your homework.
Don't just take someone's word for it. Check references, read reviews, ask for referrals, and verify they have experience performing the type of work you're hiring them to do. Just remember to use sources you trust and maintain some objectivity when evaluating online reviews.
- Have a comprehensive written agreement.
The contract should contain as detailed as possible a summary of the scope of the work and the price. If there’s any particular term or request that is important to you, make sure it is specified in the contract and don’t rely on oral promises. The contract should also specify that any changes to the contract should be in writing and mutually agreed by the parties.
- Obtain a W-9.
Before making payment, ask every contractor to complete IRS Form W-9, even if they tell you they're incorporated. The W-9 provides the taxpayer information you'll need to determine whether you're required to issue Form 1099-NEC at year-end. Be skeptical of anyone who refuses to provide a W-9 or insists on being paid "under the table." That's often a red flag that they aren't properly operating their business or carrying the appropriate insurance. Failing to collect a W-9 or issue a required Form 1099-NEC can expose your business to unnecessary IRS penalties if you're ever audited.
- Verify license, bonding & insurance.
If the work requires a professional license, make sure it's current. If bonding or insurance is appropriate for the project, verify that coverage actually exists. That includes general liability insurance and, where applicable, workers' compensation insurance for the contractor's employees. Don't simply take their word for it.If their coverage has lapsed and someone gets hurt on your property, you could end up sharing liability.
- Never pay full price up front.
There's nothing wrong with paying a reasonable deposit or retainer. From there, negotiate progress payments tied to milestones or completed work. Only make your final payment after the project is complete, you've confirmed the work meets your expectations, and you've received the required documentation, including the contractor's W-9.
- Follow proper procedure with Change Orders.
Make sure you verify in writing when the terms of the contract change or the scope of the project is modified. Never, and I repeat NEVER, agree to changes verbally. Document everything. Take pictures, do regular inspections if a physical real estate project.
- Issue 1099s.
Finally, don't forget your year-end reporting responsibilities. Generally, if you pay an independent contractor $600 or more during the year in the course of your business, you'll need to issue Form 1099-NEC unless an exception applies. The form is generally due to both the contractor and the IRS by January 31 following the tax year. Proper reporting helps close out the relationship and keeps your business compliant with IRS requirements.
The Bottom Line
One of the fastest ways to create problems with an independent contractor is forgetting that you're working with another business owner. Pay on time. Be reasonable. Don't be a pain in the rear.
There's nothing wrong with requiring written documentation, verifying insurance, or following proper procedures. In fact, that's exactly what responsible business owners do. But if you communicate clearly, treat people with respect, and honor your agreements, you'll usually receive the same in return.
Hiring independent contractors can be an excellent way to grow your business, but only if you build the relationship on the right legal and tax foundation from the beginning.
