If you're like most small business owners, your ears perk up when you hear about strategies to reduce the cost of labor overhead.
(article continues below)
Payroll is the largest line on your expense sheet and replacing full-time employees with independent contractors sounds like a simple solution to a complicated problem.
Independent contractors can deliver a net benefit to your bottom line. But the IRS is fairly strict about making sure that workers who are classified as independent contractors are actually independent contractors and not just employees by another name.
An independent contractor agreement can mitigate the risk of non-compliance. To be effective, your agreements need to address several issues that clarify the nature of the relationship and protect your business from unnecessary IRS scrutiny.
- Contractor Status. The beginning material in the agreement should discuss the nature of the relationship between the employer and the independent contractor, and describe the scope of the work that will be performed. It should address the fact that the contractor is not an employee (and should not be considered one for tax purposes), a partner or a party in a joint venture. The inclusion of the contractor's employer ID or business license number can bolster the strength of the document.
- Compensation & Withholding. Next, your independent contractor agreement should address the issues of compensation and withholding, specifically describing how much the contractor will be paid for her service and articulating that the contractor will be issued a 1099 form for tax purposes. You may want to consider using additional verbiage to clarify that the contractor will be responsible for IRS filings and withholdings, and will be responsible for any fees or fines that result from an inaccurate filing.
- Non-disclosure. Although a non-disclosure or confidentiality clause doesn't directly relate to the independent contractor's tax status, these clauses are boilerplate material for independent contractor agreements and can strengthen the argument that the individual is a legitimate contractor. At a minimum, confidentiality clauses protect your company's privileged information and trade secrets.
- Termination. Since independent contractor arrangements may not have a specific end date, it's important to include content about the legal termination of the relationship. Independent contractor arrangements can be terminated by either party, subject to advance notice requirements. This language is important for IRS purposes because it proves that the relationship is not necessarily as binding as the relationship between an employer and a typical employee.