What is an independent contractor?

Independent contractors are workers who lack the legal status of an employee. If a worker qualifies under the law as an independent contractor ("IC"), the hiring party (referred to as the "client" in this agreement), doesn't have to pay the worker's Social Security and Medicare taxes, nor does the hiring party have to withhold the worker's share of those taxes or the worker's income taxes. The independent contractor is responsible for reporting and paying all Social Security, Medicare, and income taxes on his or her earnings. (The hiring party is required to inform the IRS whenever an independent contractor has been paid $600 or more in one year.)

In addition to the reduced bookkeeping and financial obligation, those who hire an independent contractor are not bound by many of the federal and state laws that normally govern the employer-employee relationship.

How does a hiring party know whether a worker is an IC or employee?

The IRS strongly prefers that workers be classified as employees and not as independent contractors. If you hire someone and classify that worker as an independent contractor when the person actually should be classified as an employee, you can face IRS penalties. To withstand an IRS challenge to independent contractor classification, you must show that the worker will control both the outcome of the project and how the job gets done. It also helps if the hiring party can show that the worker has at least some control over how he or she charges for the job.

It's sometimes difficult to know whether the IRS will agree that you've correctly classified a worker as an independent contractor. The easy cases involve workers who clearly are in business for themselves, demonstrated by characteristics such as these:

• The worker is available to perform services for many businesses.
• The worker has a fixed base of operations -- a commercial or office location, perhaps, or a room at home -- and ongoing business expenses.
• The worker lists the business in public directories and may also drum up business through ads or a website.
• The worker undertakes a job based on the results the client wants, but remains free to decide how to get the job done.

By contrast, people who work under your close supervision for fixed wages are almost certainly employees rather than independent contractors.

If there's someone you'll be hiring and working with a great deal, consider asking the worker to incorporate. Then enter into a contract with the corporation -- not the individual. The IRS will almost always accept the fact that an incorporated worker isn't your employee but instead is an employee of his or her own corporation. Incidentally, you can form a one-person corporation in every state.

Unfortunately, some workers fall into an ambiguous area where the distinction between an employee and an independent contractor gets fuzzy. You may wish to get advice from a tax expert before classifying someone as an independent contractor. If you do decide to treat the worker as an independent contractor, having a written contract like this one may help you establish that the classification is proper.

Can a contract by itself can't create an independent contractor relationship?

A contract is useful to:

• document the financial arrangements to which you and the worker agree, and
• establish who has control over how the work is to be done.

Furthermore, a contract, by itself, can't magically convert someone who's an employee, as defined by IRS rules, into an independent contractor.