Compliantly Engage Contractors in the United States

Any business hiring in the United States should understand the important legal distinction between who is classified as an employee and who can be engaged as an independent contractor. Fines or penalties may be issued to businesses that are hiring employees under the guise of independent contractors or freelancers. 

In the United States, describing or referring to an individual as an independent contractor, when in the context of a relationship between the individual and a company, has legal significance. Various factors and acknowledged tests, as well as multiple jurisdictions, are taken into account to determine the propriety of the independent contractor classification. Therefore, understanding the distinctions between employees and independent contractors is critical to compliantly engaging workers in the United States. 

It is important to work with a partner like Worksuite to ensure that you have an engagement framework that thoroughly and compliantly assesses all facets of the classification determination. This includes an understanding of how the contractual and practical framework of projects, tasks, and other work assignments can materially impact the propriety of the classification decision.  

The Internal Revenue Service (IRS) of the United States, each state revenue office, and multiple other federal and state agencies, all have set rules and criteria for determining  independent contractor status. While there is significant overlap of the criteria across federal and state agencies, there are also many unique and specific requirements at the state and or agency level to be aware of. There is no one single test for independent contractor determination in the U.S. However, there are several key factors that are generally common across all jurisdictions to determine employee or contractor status:

• “Right of Control” tests determine who controls delivery of the services, the client company or the worker?
• Is the worker an “independently established business” and conducting their business as such?
• Does the worker maintain “financial control” over her or his business, including financial risk for delivery of the services to the client company?
• How distinct are the worker’s services from the “usual course of business” conducted by employees of the client company?

The three most important steps of structuring an independent contractor relationship in the U.S. are to

1. document the nature of the relationship between the parties as independent contractor, 
2. document the services to be delivered (i.e. deliverables or expected results) and compensation to be paid based on that delivery, and
3. ensure that all work is delivered according to the terms of the contract and not similar to existing employer-employee relationships.

Without these steps, workers initially classified as independent contractors are at risk to be reclassified as employees. The misclassification claim, and ultimately the final classification decision, would be made by any of the myriad of governmental authorities noted above or by a court of law.

Who is an independent contractor?

• In general, independent contractors are people in business for themselves. They typically provide services that client companies cannot or do not provide as their regular course of business or they perform work that requires specialized skills. They also typically provide their services to multiple customers or clients, set their own prices or fees, work from their own place of business (i.e. home or remote), use their own tools and resources for delivery of their services, and control how and when the work is to be done.
• According to the IRS: Whether people are independent contractors or employees depends on the facts in each case. The general rule is that an individual is an independent contractor if the payer (client company) has the right to control or direct only the result of the work and not what will be done and how it will be done. You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.
• Each state defines independent contractor status or criteria differently. 

There are two general contractor models in the U.S.

Agency Contractors. Contractors who work for or rely upon agencies to place them and to provide certain administrative and risk management functions on their behalf. 

Independent Contractors. Independent contractors typically sign an Independent Contractor Agreement, not relying upon support of an agency for placement  or management.

There are two primary engagement models for working with freelancers who are to be engaged as independent contractors in the U.S.

A. Direct engagement of the worker as an Independent Contractor. Under this model, the hiring company engages directly with the independent contractor and establishes a direct contract for the provision of services. The hiring company then pays the independent contractor directly, in accordance with the terms of the independent contractor agreement or statement of work contract.

B. Agent of Record. Agent of Record (AOR) firms screen and engage freelancers as independent contractors on their client’s behalf. AORs specialize in the proper classification of workers as independent contractors and managing the ongoing risk of misclassification during the workers’ engagement with client companies. 

Companies hiring independent contractors in the U.S. should make payments to independent contractors as they would any other third-party vendor or business they engage. 

If you work with an agent of record or a freelance management system like Worksuite, the contractor payment processes are significantly streamlined and foreign exchange risks are effectively managed. A dependable partner can help you hire your contractors legally and pay them quickly, accurately, in the local currency, and in a way that complies with U.S. regulations.

Independent contractors in the U.S. are responsible for reporting and paying their own income tax. Client companies file Form 1099-NEC with the IRS when payments to individual independent contractors exceed $600 annually. Independent contractors also receive the Form 1099-NEC from the client company for use in their individual or business tax filings. 

Income Tax

The Internal Revenue Service requires individuals to pay self employment taxes on all earnings as an independent contractor. Further, the IRS requires quarterly estimated tax reporting and payments on income derived from independent contractor or 1099 classified engagements. 

Compared to employees, independent contractors have access to significant tax advantages. They can write off several business expenses, giving them the potential to reduce their relative taxable income.

At the same time, employers can be tempted to classify workers as independent contractors by the prospect of lower costs (no employer side payroll taxes or employee benefit contributions) and lessened administrative burdens (no payroll deductions). 

These double-sided incentives are one of the main reasons why employees frequently end up wrongly classified as independent contractors in the U.S. Employers should take significant care to avoid this situation. Working with a partner like Worksuite is a major step towards ensuring ongoing compliance with all relevant United States federal and individual state legislation.

We can simplify hiring full-time workers in the United States by acting as the Employer of Record (EOR) on your behalf, handling everything from contracts, onboarding, documentation, payroll, benefits, and workforce management. Reduce your time-to-hire by 90%, slash your overheads, and remain fully compliant.

• Quickly find, hire, and onboard talent in the US without setting up your entity
• Prevent expensive legal, contractual, or tax mistakes in the US
• Manage contracts, payroll, and global tax forms all in one Worksuite