Consultants (a.k.a. independent contractors) are a cornerstone of the global economy. Even though consultants seemingly carry “less” regulation vs hiring employees, make no mistake there are legal pitfalls and best practices that you should know about.
Hiring Independent Contractors Who Should Really Be Employees
Hiring consultants is much cheaper and easier than hiring employees. As a result, employers are tempted to hire people as contractors even though they should legally be classified as employees. Federal and State Labor agencies are heavily cracking down on misclassifying employees with massive fines and penalties.
The IRS has laid out guidelines for determining whether someone should be classified as an independent contractor or an employee. While no single guideline is determinative, the following are continuously pointed to as red flags for auditors:
- The consultant uses the company’s tools (namely computers);
- The consultant works according to proscribed weekly work schedule (9am – 6pm); and
- The consultant only works for the company.
The classic consultant is a plumber or lawyer. Real consultants use their own tools, set their own hours, and have many clients.
Non-Disclosure Agreement
Before you work with a consultant, you will probably need to disclose a few things. NDAs can help in this initial information exchange. Some people like NDAs, others do not. Your Consulting agreement SHOULD HAVE a confidentiality clause in it, so NDAs are really for pre-relationship discussions.
Getting the W-9
A W-9 is the IRS form used by a company to request a taxpayer identification number. A business using an independent contractor should request a W-9 from the contractor which certifies that the tax id number is correct. The business keeps the W-2. No is filings required.
Consulting Agreement
The consulting agreement is at the heart of any consulting relationship. Even if you have worked with the consultant before, and there is no chance of a conflict ever arising, spend the time to properly define the relationship in writing. Properly define the contractor’s work and expectations. The more detailed the better. You should also clearly communicate what is considered “conforming work product,” especially if someone must approve the work. Finally, make sure to set milestones to which payment is tied, and contemplate what happens if a milestone is not achieved. Properly drafted contracts can help you and your consultant get through unforeseen hiccups.
Register Consultant with State if Necessary
In many states, any business or government entity that is required to file a federal Form 1099-MISC for services received from an independent contractor is required to report specific independent contractor information to the state’s employment department. Depending on your state, there can be fines for ignoring this. Check with your individual state for compliancy regualtions.
Terminating the Relationship
If your Consulting Agreement has an early termination clause (many do) it most likely has a “notice” requirement. A notice requirement will usually state that the Agreement can be terminated with “X” days notice. Notice can be sent via email or traditional mail.
Filing the 1099
A 1099 is required for any contractor unless: 1) the recipient is a corporation; 2) the payment is for a tangible product (office supplies, computers, etc); or 3) the total payments during the calendar year were less than $600. The hiring entity fills out the 1099, the consultant signs it, and then the business files the 1099 (and all other 1099s) with the IRS. Unfortunately, official 1099s need to be requested from the IRS or a local tax office.
Matt Faustman is the co-founder and CEO of UpCounsel, an online marketplace for legal services focused on businesses and startups. Before co-founding UpCounsel, Matt worked as an attorney in Silicon Valley representing startups and technology companies.
