Thinking about Hiring a Contractor this Year?
Thinking about Hiring a Contractor this Year? Read this First.
Hiring an independent contractor can be a smart move for a growing business. Contractors offer flexibility, specialized expertise, and can help you scale without the long-term commitment or potential HR headache of recruiting, hiring, and onboarding a new employee.
That said, contractor relationships come with real legal, tax, and bookkeeping responsibilities. Missteps—especially around classification—can be costly. Classification simply means – is the new person you bring on an employee or a contractor. There’s more to this than you might think.
Before you bring a contractor on board, here are the most important tips and steps to keep your business on solid ground.
1. Understand the Difference: Contractor vs. Employee
This is the most critical step—and the one businesses get wrong most often.
In general:
• Employees are directed (by you or another employee) how, when, and where to work.
• Contractors control how the work is performed and usually serve multiple clients.
If you set work schedules, provide detailed instructions, require ongoing core work, or control how the work is done, you may be dealing with an employee—even if you call them a contractor.
2. Apply the Correct Classification Test
Different agencies use different tests, including IRS, state labor agencies, and employment security departments. Classification is not a choice—it is a legal determination based on facts. The IRS published a helpful (and thankfully concise) guide explaining classification in further detail.
3. Use a Written Contractor Agreement
A written agreement should define scope of work, payment terms, independent contractor status, tax responsibility, confidentiality, ownership of work product, and termination terms.
4. Collect Required Tax Forms Up Front
Before the first payment, obtain a completed W-9. A W-9 is an IRS tax form that collects a few pieces of specific information from contractors regarding their taxation status. This form is important to collect for all types of contractors. At year-end, issue Form 1099-NEC if total payments are $2,000 or more. There are some additional nuances to issuing 1099’s and more information is available here from the IRS or visit with your bookkeeper or accountant.
5. Pay Contractors Correctly
Contractors are paid through accounts payable, not payroll. Taxes are not withheld from payments made to contractors, and payment should be based on invoices, projects, or agreed upon milestones.
6. Review Insurance and Licensing
Depending on the type of work, contractors often need their own business license, insurance, or certifications. Collecting evidence of these items up front and keeping a copy on file is best practice.
7. Keep Clean Records
Maintain up to date contracts, W-9s, copies of licenses, bonds and/or insurance, invoices, payment records, and any contract amendments. Good documentation protects your business.
8. Re-Evaluate Long-Term Relationships
Long-term contractor relationships should be reviewed periodically to ensure they still meet legal classification standards. It is easy for these long-term relationships to creep into an employer-employee relationship.
Conclusion
Hiring a contractor can be a great business decision when done correctly. Thoughtful classification, documentation, and bookkeeping help protect your business and support sustainable growth.
Disclaimer: This document is provided for general informational purposes only and does not constitute legal, tax, or accounting advice. Contractor classification rules vary by jurisdiction and depend on specific facts and circumstances. You should consult with a qualified attorney, tax professional, or accountant regarding your individual business situation before taking action.
