An Independent Contractor Agreement is a written contract between two parties for a specific service or project. One person or company is hiring another to help on a short term task. Unlike an employment agreement, this document clearly spells out why the party being hired is not an employee for legal and tax purposes.
It might seem obvious when you hire an independent contractor or subcontractor to have them signed a contractor or subcontractor agreement, but for some reasons many businesses, prime and subcontractors fail to draw the line.
- Insurance (The contractor does not provide worker’s compensation insurance for subcontractors)
- IRS tax withholdings
- The subcontractor’s required provision of a W9 to the contractor.
- The contractor’s required provision of a 1099 form at year’s end for the subcontractor’s tax filing purposes.
- Self-employment tax payments being the responsibility of the subcontractor.
- The absence of any promise to pay for profit sharing, pension, paid holidays, paid vacations, insurance, unemployment compensation or any other employment benefits.
- The responsibility of the subcontractor to pay for Social Security benefits.
- The subcontractor’s responsibilities for providing health insurance
The subcontractor agreement will include a clause for defining the payments the subcontractor will receive. Payments are based on the scope of the work. If more time to complete the work is something required, the contract will include information about the additional payment. Hourly, weekly, biweekly, or monthly information will be included in this area of the contractual form. Additional details include:
- Maximum work hours each week or month.
- Subcontractor payment milestones.
- The expected timing of invoices.
- What happens in there is more time needed and the fixed price doesn’t cover the added time.
- Whether the project has a fixed price or flexible payment option
Keeping track of who is an employee and who is a contractor ensures a business is in a position to file taxes properly and comply with employment law.
Employers must pay a portion of payroll taxes on employees, whereas independent contractors conduct their own personal tax filings.
What happens when employees are misclassified as independent contractors?
The U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS) conduct regular company audits with the goal of finding employees who have been misclassified as contractors.
The consequences for such misclassifications can range in severity depending on whether or not the misclassification is intentional, unintentional, or fraudulent. But regardless, the sub may choose to sue for compensation that are owed to them as employees because you failed to clearly specify the relationship through a contractor agreement.
The ramifications for classifying employees as independent contractors can include:
- A $50 fine for each unfiled W-2 form
- Monetary penalties from failing to withhold income taxes (potentially 1.5% of paid wages, 40% of FICA taxes not taken from employee wages, and potentially interest for late filing)
- A failure-to-pay tax penalty, which can total anywhere between 0.5% and 25% of the employer’s taxes depending on how long the employer has misclassified the employee and failed to pay the appropriate taxes
The IRS might also impose additional fines and penalties if they suspect fraud or intentional employee misclassification.