Working with Independent Contractors (ICs) can be complex to navigate for a number of different reasons. As employment experts, Dahl Consulting (DAHL) understands the challenges and risks that ICs present to companies that utilize this form of employee. This article and guide can help you and your business to better understand how to work with ICs while complying with laws and regulations. We will cover what the ICs are, the complexities of working with ICs, the legal costs of misclassification, and lastly, how DAHL can help.
What are Independent Contractors (ICs)?
According to the IRS, if the paying entity has the right to control or direct only the result of the work and not what will be done/how it will be done, then the individual is an independent contractor (IC). If you are an IC, then you employ yourself. Unlike “traditional employees,” ICs are not considered employees of the business that they are working for; instead, they are considered self-employed and work on a project-to-project basis under a contractual agreement. They are responsible for their own taxes, benefits, and work arrangements. If ICs are misclassified, it can lead to an onslaught of legal issues and financial consequences.
What do I need to know about working with ICs?
There are many benefits to working with ICs, such as employment cost savings, reduced HR-related administrative burden, and scalability. However, ensuring compliance and having a set process is critical, especially when it comes to classification. Employers should also be knowledgeable about what they are responsible for concerning taxes, retirement savings contributions, insurance benefits, and payroll. We will cover each of these areas below.
The most important thing to remember when classifying an individual as either an employee or contractor is whether or not the business has the right to control how a worker’s services are performed. If you are working with an IC, you cannot tell them when to work or how to complete the project or assignment. Additionally, there are financial factors to consider, such as how the worker is paid, how expenses will be reimbursed, and who is responsible for providing tools and supplies. Lastly, there should always be a written contract for ICs that details benefits and the employer’s responsibilities. For more information on classifying ICs, view our IC Classification Guide.
Independent contractors may also be referred to as 1099 workers because these individuals receive the IRS Form 1099-NEC, Non-Employee Compensation, instead of Form W-2, Wage and Tax Statement. Hiring entities and payers use a 1099 form to report the amount that they reimbursed ICs over the past year. In addition to a 1099 form, ICs fill out Form W-9, which provides their name and taxpayer identification number (TIN). According to the IRS, this document should be saved by the paying company for at least four years.
Employers do not need to withhold any employment-related taxes because ICs pay a self-employment tax, which includes a combination of Social Security and Medicare taxes. The only exception to this is if an IC provides the incorrect TIN or provides incorrect income taxes on their returns. If this happens, a backup withholding may be required, in which employers must withhold a percentage of an IC’s payments to deposit to the IRS.
Lastly, ICs are usually required to pay a quarterly tax, using Form 1040-ES, Estimated Tax for Individuals. Quarterly payments are preferred to avoid a large bill at the end of each tax year.
Because ICs are not paid in the same way as traditional employees, they will need to be paid according to a contractual agreement or Statement of Work (SOW), as opposed to being a payrolled employee. Contractual agreements should outline the scope of the work to be performed, payment terms, deliverables, and other specific details. Typically, ICs are paid either on an hourly basis or upon project completion.
It is important to note that depending on the Independent contractor, the Taxpayer ID Number (TIN) issued by either the Internal Revenue Service (IRS) or the Social Security Administration (SSA) may differ. TIN is the umbrella term for SSNs, EINs, ITINs, ATINs, and PTINs. If an IC runs a sole proprietorship (does not have employees and does not file excise or pension plan tax returns), their TIN number will typically be their SSN. However, sole proprietors can also get an EIN, although not required. If an IC runs a business (has employees, operates as a corporation, LLC, or partnership), they utilize an EIN as their TIN.
To set up the payment process for an IC, follow these steps:
- Obtain the IC’s Form W-9 and request their TIN.
- Provide compensation to IC for work performed according to contractual agreement.
- Remit backup tax withholdings to the IRS (if necessary).
- Independent contractors will complete Form 1099-NEC.
As covered previously, the IC will be responsible for their own federal payroll taxes, so employers do not need to account for these unless there are backup withholdings required.
Retirement Savings Contributions
Another perk of working with ICs is that they are responsible for their own retirement savings. Employers are not obligated to make contributions to any of their retirement accounts as you would with a traditional employee.
Independent contractors can choose from a variety of retirement savings accounts, including Individual Retirement Accounts (IRAs), Simplified Employee Pension IRAs (SEP IRAs), Solo or Individual 401(k)s, or a Keough Plan. Regardless of what accounts these individuals select, they will be responsible for managing and contributing their earnings to these accounts.
Insurance & Benefits
In addition to retirement savings, employers are also not required to provide insurance or other employment-related benefits to ICs. Because ICs are considered self-employed, they are not regarded as employees of your business, and therefore, they are ineligible for company coverage and benefits.
What are the legal repercussions of misclassification?
There are a number of legal repercussions for misclassification of independent contractors. They include the following:
- Loss of federal and state contracts: Many government agreements have specific requirements pertaining to labor classification, so failure to comply with these requirements can result in contract termination, penalties, and disqualification from future contracts.
- Delinquent payment of taxes, contributions, and insurance premiums: If a worker is misclassified as an IC when they are actually an employee, this can result in failure to withhold and pay payroll taxes (such as Medicare and Social Security) as well as unemployment insurance contributions. This can cause delinquent payment of taxes and can cause businesses to incur additional penalties, including interest charges.
- Tarnished brand and negative press: Misclassification can negatively impact your company’s image and brand, as it is generally considered exploitative and unethical.
- Class action lawsuits, in addition to attorneys’ costs and fees: Misclassified workers who should have been classified as employees may file lawsuits seeking reclassification and claiming unpaid benefits, wages, and more. These lawsuits can cause substantial financial detriment to a business, especially if a class action status is granted.
- Unpaid business expenses and overtime reimbursement: Misclassified workers may also seek reimbursement for overtime and any applicable business expenses.
- Accountable for loss of employee benefits coverage: Businesses may also be held accountable for the retroactive benefits of misclassified employees, including but not limited to health insurance, retirement plans, and paid time off (PTO).
The legal repercussions of misclassification can be severe and may vary depending on the jurisdiction and nature of the violation. It is critical for businesses to ensure that they correctly classify employees and independent contractors to avoid lawsuits, legal fees, and damaged reputations. Luckily, working with an employment expert can help significantly reduce the employment risks of working with ICs and simplify the process.
How can DAHL help?
Dahl Consulting effectively indemnifies your organization against the misclassification of workers. We can help your business work with ICs by creating separation between your business and the ICs themselves. DAHL serves as the Agent of Record (AOR) and takes full responsibility for all aspects of IC compliance.
DAHL’s IC Compliance Solution delivers full lifecycle administrative management of your ICs, effectively controlling costs and reducing risks for your business. We also handle contract management and payment for ICs, making the process even more streamlined and stress-free. Below is a complete list of the benefits we provide when you choose to work with us for IC management:
- Top-notch compliance
- Contracts held directly with DAHL
- Onboarding, Offboarding, and Employee Insurance Programs (if applicable)
- Full document management, including collecting, storing, and tracking
- Policy, contracts, and agreement governance
- Streamlined and single-source invoicing efficiencies
- Dispute resolution
DAHL is a trustworthy and reliable contingent workforce expert who can help you with the management of independent contractors. Our compliance team is well-versed in state and federal laws and understands the ins and outs of reducing employment risks associated with ICs. If you have any questions related to working with ICs, connect with our team of experts today!
Check out our helpful Independent Contactor Classification Guide by clicking the button below.