Independent Contractor Agreements and
Advantages and Disadvantages
of Independent Contractors

Independent Contractor Agreements

Using a written Independent Contractor Agreement avoids later disputes by providing a written description of the services the IC is to perform, when they are to be performed and how much the Independent Contractor will be paid.

A written Independent Contractor Agreement can also help establish a worker's Independent Contractor status. Although an agreement by itself is not enough to make a worker an Independent Contractor, it will help show the IRS and other government agencies that both you and the worker intended to create a hiring firm Independent Contractor relationship, not an employer employee relationship. Newly published IRS training materials state that where all the other factors are evenly balanced, a written Independent Contractor Agreement may tip the scale to the Independent Contractor side. An Independent Contractor Agreement is only useful if it's enforced.

Benefits of hiring Independent Contractors

Independent Contractors and Economics

Businesses can save money by hiring Independent Contractors instead of employees. In addition to salaries or other compensation, employers usually must pay employee expenses, for example:

  • federal payroll taxes, including a 7.65% Social Security tax and a usually small (.08%) federal unemployment insurance tax
  • state unemployment insurance premiums
  • workers' compensation insurance premiums
  • employee benefits, such as health insurance, paid vacations, sick leave, retirement benefits and life or disability insurance, and
  • office space and equipment.

These expenses add at least 20% to 30% to payroll costs. For example, if you pay an employee $10 per hour, you will probably pay another $2 to $3 per hour in employee expenses. You incur none of these expenses when you hire an IC. So even though ICs are often paid more per hour than employees doing the same work, they still cost less.

In addition, when you hire Independent Contractors instead of employees, you have reduced exposure to some types of lawsuits, such as those alleging job discrimination or wrongful termination.

Finally, and most important for many firms, ICs provide a level of flexibility that can't be obtained with employees. You can pay an Independent Contractor to accomplish only a specific task, allowing your business to get specialized expertise for a short period. You need not go through the trauma of laying off or firing an employee. Moreover, an experienced Independent Contractor can be productive immediately, eliminating the time and expense involved in training employees.

Risks of hiring Independent Contractors

Businesses are caucious of using Independent Contractors because they have heard about or experienced the consequences of misclassifying as Independent Contractors workers who are, legally, employees. And it's true that the consequences can be financially dramatic. A business must pay the IRS all back taxes owed, with interest, plus a penalty of 12% to 35% of the tax bill.

Audits by state agencies are even more common than IRS audits. State audits most frequently occur when workers classified as Independent Contractors apply for unemployment compensation after their services are terminated. An investigation by your state unemployment compensation agency will follow, and you will be subject to fines and/or penalties if it is determined that workers should have been classified as employees for unemployment compensation purposes.

Another major disadvantage of hiring Independent Contractor is that they can sue you for negligence if they are injured on the job. This is something employees covered by workers' compensation normally cannot do.

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