According to the Bureau of Labor Statistics, independent contractors made up a whopping 6.9% of the American workforce in May of 2018 – and that doesn’t even account for the on-call and temporary workers who make up roughly another 3% of the rest of the alternative worker statistic. These figures show that companies across the nation are employing a blended workforce strategy to diversify their workforce and support their staffing plans. It’s a move that gives employers added flexibility, especially during the times that they might need it the most, like seasonal peaks and aggressive scales.
But, just because roughly 1 in 10 members of the workforce will take on alternative employment positions doesn’t mean that companies can simply hire and let go of them haphazardly. Contractors come with their very own subset of labor laws, hiring rules, and most all require unique tax scenarios, as well. Once you get a handle on the differences between full-time/part-time employment and contract labor, you will be able to diversify your team with this flexible, talented group of workers.
To get you better acquainted with the ins and outs of adopting your own program, we’ve compiled a comprehensive guide that answers all of the questions you need to know about contract labor. This guide discusses:
- A General Overview of Contract Labor
- The Many Benefits that Independent Contractors Bring to Companies
- Things to Remember When Hiring Independent Contractors
- Standard Practices Used in Employing Contract Labor
- Additional Resources on Contract Labor
A General Overview of Contract Labor
Although the burgeoning gig economy is currently expanding by the day, the use of contract labor is something that has been around for decades, and it is hardly high-tech. Contract labor, otherwise known as independent contractors, are simply workers who work under individual contracts and are never hired on full-time by a company (though they could work just as many hours as a traditional employee).
Here are some examples of what sets contract labor apart from traditional employee labor:
- The worker submits their own invoices for the projects/hours completed
- The worker can negotiate or control the number of hours worked
- The worker can use or is required to use their own equipment to complete the assigned work
- The worker can be let go from the position at any time, granted this doesn’t break the contract (more on this later)
- The worker is not paid benefits, such as health insurance, Social Security, Medicare, worker’s compensation, state unemployment, the Family Medical Leave Act, etc.
- The worker is provided a 1099-MISC tax form once the contract has commenced or, most commonly, at the end of the tax year
As their name suggests, most independent contractors require a contractual agreement before work can begin. Depending on the specifics of the industry in which they work, the terms of the contract might include: the maximum amount of work hours per week/month, listed conflicts of interest, an intellectual or copyright agreement, an injury liability clause, a breach of contract clause, and a clause detailing early termination scenarios.
Generally, companies will employ attorneys to write these contracts, with a new contract being devised for each role or contractor. For instance, a contractor who is hired to drive a forklift will require a different contract than one who is hired to design a company website. In other words, the contracts of these workers are hardly one-size-fits-all.
Once the contracts are written and cleared, they can be reused as templates (like this one) as long as no job requirements or labor laws change in the meantime.
Though the idea of bringing contract labor into your workplace might seem like a relatively simple act, it’s important to remember that, due to stringent tax laws, every single person that you pay must have a well-defined position. Of course, this person must also be able to be easily traced through tax records.
If a part-time, full-time, or even statutory employee gets lost or hidden into the independent contractor mix, you could find the IRS knocking on your door. To avoid this, simply keep all of your necessary team members in the loop about your worker classification system, including business managers, trusted tax professionals, HR personnel, attorneys, etc.
The Many Benefits that Independent Contractors Bring to Companies
There’s a reason why alternative and contingent workers make up around 10% of our nation’s workforce. These often skilled workers are able to add value to companies of all sectors by giving them flexibility in terms of hours/days worked, lengths of employment, and the fact that most come with their own equipment to do the job such as tools, computers, cars, etc.
Having said that, there is a host of other ways companies can benefit from contract labor. Here are some of the often overlooked or lesser-known advantages:
- Contractors usually cost less than employees. According to data published by Chron, independent contractors cost companies 20-30% less than employees, even when the hourly breakdown is similar. This is because employers are not required to pay the contractor’s benefits (i.e., Social Security, healthcare, etc.).
- Contractors can maintain flexible positions. Employers have much more flexibility when it comes to contractors. This is especially true in situations where employers might wish to extend a project – or even complete one earlier than expected. Because contractors require no real promises in terms of employment length, the employer must only adhere to the stipulations made in the initial contract.
As with all labor statutes in this country, things can vary greatly depending upon the state and local laws, especially when it comes to things like workers’ comp. This is why it’s important to have a trusted legal professional review your blended workforce staffing plan before you enact it. Misclassification of these workers cannot only put a business in jeopardy when tax-time comes, it can also spell serious legal trouble, too.
Things to Remember When Hiring Independent Contractors
According to our friends over at the IRS, the biggest rule to follow when hiring independent contractors is to first define the position. Too many times, employers misclassify their independent contractors as being employees, and vice-versa. Until the company is clear on their exact needs, there is no way to be sure that the bounds aren’t being overstepped.
Let’s look at this situation, for example:
A new worker is hired under the assumption that there is a sense of permanency in the relationship. It’s clear that the company will reimburse the worker for all business expenses because this person is contributing to the regular output of the company. The company has nearly full control of the workers’ earnings, the ways in which they are paid, and when/why bonuses will be allocated.
Looking at the example, you’ve likely come to the conclusion that this worker is an employee of the company, not an independent contractor. In this case, the employee is entitled to all of the protection outlined in the sections above, such as workers’ compensation, maternity/paternity leave, health insurance, etc. Additionally, employers must withhold income taxes, pay Social Security, Medicare, and unemployment taxes to regular employees.
All of this means that, when a company is hiring a contractor, it must be crystal clear in the initial agreement that the worker is, in fact, categorized as an independent contractor – and the 1099-MISC tax form must be filled out to prove it.
Having said that, if there are any changes in the relationship (for instance, if the independent contractor is now suddenly expected to maintain a 9-5, 40-hour/week schedule that was not specifically outlined in the original agreement), the contract must be updated. Creating updates guarantees that there is no ambiguity in the classification of the worker and that either they nor the IRS, can come back later questioning the validity of the contractual agreement.
If either the worker or the employer feels that the category of the position is too difficult to determine, the IRS provides the SS-8 Form, otherwise known as the Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. This form can be completed and sent to the IRS to determine the position’s category before the worker signs the contract. That way, if an audit does occur or an independent contractor disputes their employment categorization later on, the company can be immediately cleared once the approved SS-8 form is furnished.
Standard Practices Used in Employing Contract Labor
Once everyone involved in the hiring of the independent contractor, including the legal team, the HR management, and the relevant employees are clear on the employment categorization, it’s time to begin the onboarding process.
Of course, it’s quite a different process for independent contractors, as many might not be required to undergo the same training protocol and introductory meetings required for employee onboarding. Generally, contractors are hired for their “plug and play” skills, meaning they have the ability to get the job done immediately, with little to no onboarding required.
Having said that, all too often employers, especially ones who are new to the world of contract labor, have a hard time establishing and/or following a good set of standard practices. In her article for the Society for Human Resource Management, Navigating Employment Law in the Gig Economy, Margaret M. Clark, J.D., SHRM-SCP reveals that the biggest mistake companies make when hiring independent contractors is that they do not create a “sense of distance.”
Now, this sentiment might sound inherently wrong as, ordinarily, American firms strive for inclusion, but following this practice tends to lead to confusion when contractors are involved. For instance, contractors should not be burdened with handbooks, supervisors, or performance evaluations – they are simply there to be productive, not to fit into the culture of the company.
Breaking it down, this means no extraneous training for a variety of reasons; it’s generally a time-suck, and it can lead to issues if they are not be compensated for these periods. Remember, independent contractors only get paid for the work they submit or perform (unless otherwise specified in their contract), so if they are suddenly made to undergo the same tasks of the ordinary employee, the lines can become blurred.
Naturally, this is a multifaceted situation in which distance isn’t always possible. If the contractor is working in an office, for example, and they experience harassment or a safety issue, they should be given the same amount of rights as a regular employee. Providing the contractors with ways to report problems is part of the employer’s promise to maintain a safe work environment.
Companies reap myriad benefits by using contract labor, but following all applicable rules and regulations is paramount for long-term success. If you try to fly under the radar and skirt around the rules (such as by misclassifying workers), it could be a costly mistake if you end up being penalized by the IRS or another authority. So, know the rules, follow them closely, and use smart screening practices to get the maximum benefit from your contract labor.
Additional Resources on Contract Labor
For even more information on contract labor laws and best practices, visit the following resources:
- Employing Independent Contractors
- Top Ten Tips for Using Independent Contractors
- The Do’s and Don’t’s When Using Independent Contractors
- Three Ways to Mitigate Risk When Engaging Independent Contractors
- Should You Hire an Independent Contractor or Employee for Your Group Practice?
- The U.S. Independent Contractor Laws: What Every Company Should Know
- Hiring Independent Contractors Abroad
- Understanding Whether Your New Hire is an Employee or Independent Contractor
- How Does a Company Properly Terminate Independent Contractors?
- Ask Rita: Can I Just Hire Independent Contractors?