Remember those times when thousands of people were working in the same office and sharing cubicles with their colleagues?

They were needed to be there. Sitting next to each other. Answering phone calls from their clients or bosses. Sometimes bosses of their bosses.

There was not much to do in the office other than chatting with colleagues about difficulties and joys of life, gossiping or reading newspapers when they got bored of being on the phone.

Of course, lots of coffee and donut breaks. Especially when the bosses were not around…

Those were the times when a company needed to hire one employee for every three clients or a manager they had. Scalability? Below zero.

Now, the economy has changed.

Efficiency and productivity have become the ultimate goals for all businesses.

Tools with smart algorithms send e-mails, share reports, or even answer calls and reply to clients.

Decision Support Systems analyze what employees do daily, weekly and monthly in order to introduce performance measures and deliver countless data, which would have been done by managers back then.

Colleagues working in different continents contribute to the same project for years, without even speaking the same language or seeing each other. Not shaking hands for once.

If you are one of those who strive to be successful in this new form of business world, and your startup is growing too big for a garage or a desk in a co-working space, then the first concern you have is how to scale your operations by recruiting the right people.

Seriously, how do you find good candidates who can fuel your growth? Should you hire them as independent contractors or employees? How much should you pay them?

Here’s what happened: Uber brought the entrepreneur’s perennial dilemma of hiring to spotlight when it got into legal battles about misclassifying employees as independent contractors. Many entrepreneurs learned that they could get penalized for not taking steps to establish the right work relationship.

Let’s not jump into conclusions though. Hiring independent contractors might carry some risks that startups want to avoid; however, benefits might be more for many entrepreneurs who want to have access to the pool of highly talented workers quickly and cost-effectively.

Hopefully, this post will help you find out when you might want to hire independent contractors and how you can get the most out of hiring them without adding legal risks.

1. What is an independent contractor in the first place?

Independent contractors, or freelancers, are entrepreneurs just like startup owners.

Their focus is taking responsibility for their products, getting things done efficiently and delivering good quality of service consistently.

This is the only way for their customers to continue hiring them on a regular basis, so they can eventually make money.

They just like to do this in an environment of their choice, rather than in a setting their manager or CEO design with limitations like an office space.

They still deliver the services and results customers expect from them. They know what quality of services is and why it is important.

Their objectives and agendas are similar to the ones of companies and startups:

• Provide good values
• Satisfy customers
• Bring them back
• Make profits

2. Should a startup hire independent contractors for business tasks?

A company or startup can reach their goals, which are in most cases to grow faster with higher efficiency and productivity, by creating a team of people who share a similar mindset to theirs and deliver high quality services constantly.

Deciding to hire independent contractors requires a careful assessment of the company’s goals and circumstances. Yes, they have various tempting sides; however, they come with some risks. Here are some of the key considerations:

Advantages of hiring independent contractors:

Every startup has the same goal. “Spend small, do big”.

The biggest benefit of hiring an independent contractor for a startup is its affordability. It is actually a lot less expensive than hiring employees in the long run, thus you can canalize the money saved here to customer acquisition, marketing, development, sales, operations or any other budget for business growth.

Office expenses are also eliminated by definition, so is that the icing on the cake or what?

Another advantage of working with a freelancer is that you know they embrace a similar mentality to yours in terms of doing business. As mentioned above, they aim to provide good values and satisfy their customers with high efficiency and productivity.

With many other aspects being considered, here’s the advantages list:

• Saving cost of employment tax and employee benefits

• Leveraging similar mindsets
• No need to maintain office space or equipment

• Greater flexibility in hiring and letting go of workers when you have fluctuating workloads
• Obtaining specialized talents immediately without the need of training
• Less exposure to lawsuits by employees who have various legal rights

Disadvantages of hiring independent contractors:

IRS is well aware that companies hire independent contractors to save tax, and it has been aggressive to pursue the lost tax revenues from the companies. So, the potential government scrutiny is one of the biggest drawbacks of hiring an independent contractor.

Also, as the silver rule of economy implies, if the demand for services of your freelancer increases, their hourly rates may increase as well.

Along with some additional considerations, the disadvantages list turns out to be:

• Risk of government scrutiny
• Potential rise of hourly rates due to increasing interest for services
• Not being able to control how and when the work is done
• Lack of stability and continuity because independent contractors can come and go
• Not possibly being able to bring the best talents on board without security of employment and many perks other startups add to entice them

3. What are the most crucial things to look for when hiring independent contractors?

You need to be just as diligent in screening independent contractors as you are with traditional employees.

Most companies hire independent contractors because they can get the work done on their own and save company’s time and resources. So, a startup can benefit from hiring contractors who are proactive, self-sufficient and self-motivated.

Experiences & Skills

Checking experiences and skill sets required for the job is one of the most important things an employer should do.

References & Sample Works

Request multiple references and work samples or put them through skills assessments before hiring.

Communication

Another thing to look for when hiring a freelancer is the ease of communication. Interviewing the independent contractor with a video call might be a good idea to see the communication skills they have.

Accessibility / Response Time

Freelancers usually work off-site and are not regularly monitored by your team, so you need to make sure they are responsive to your requests (under the logical terms) and willing to report how things are moving forward frequently. Where the contractor lives can be a vital factor here, if you do not want 12-hour delays in communication.

4. Must-dos if the startup is incorporated in the US

As we discussed earlier, hiring independent contractors carries legal risks that don’t exist when hiring employees.

One of those risks is misclassifying employees as independent contractors.

Governments pursue companies that misclassify their workers because they don’t have to withhold income taxes or pay Social Security, Medicare or Unemployment tax.

Before hiring independent contractors, check the IRS’ 20-fact test.

And the US Department of Labor’s six “economic realities” factors. 

In addition, states might use different tests and factors based on relevant court decisions in their jurisdictions.

Review the facts of your work relationship based on your understanding of applicable laws to avoid any misclassification claims.  

Make sure that you have signed independent contractor agreements and non-disclosure agreement (NDA) before starting to work together.

More information concerning agreements is provided below.

5. Must-dos if the startup is incorporated in a tax haven or any other country

Just as a startup in the United States has to be familiar with US labor and tax laws, it is important a startup incorporated in another country understands that country’s laws.

When a contractor is from a different country from where the startup is incorporated, parties can agree to choose one of the parties’ countries or a third country as a governing law of the contract.

Make sure that you or your lawyers check out both the state and country’s laws where the startup is incorporated and local laws and regulations where the independent contractor is located.

6. Documents required for hiring an independent contractor

Types of documents and government forms to be completed depend on the situation. Either way, it is important to have a written contract that evidences the agreed terms between parties.

Case #1: A US startup hires an independent contractor from the US

• Independent contractor agreement
• Collect personal identification information and request a contractor to complete W-9.
• File Forms 1099 and 1096 by January 31st of the year following the year subject to filing.

Case #2: A US startup hires an independent contractor from a non-US country

• Independent contractor agreement
• Collect personal identification information and request to fill out W-8BEN (for individuals) or W-8BEN-E (for entities)
• No need to report payments made by filing 1099 and 1096 to IRS

Case #3: A non-US startup hires an independent contractor from the US

• Independent contractor agreement
• Determine if the company is required to file a US tax return
• If it is required to file a US tax return
  • Collect personal identification information and request a contractor to complete W-9.
  • File Forms 1099 and 1096 by January 31st of the year following the year subject to filling.
• If it is not required to file a US tax return
  • No need to report payments made by filing 1099 and 1096 to IRS
  • Find out if there is any reporting requirement in the country of incorporation

Case #4: A non-US startup hires an independent contractor from a non-US country

• Independent contractor agreement
• Determine if the company is required to file a US tax return
• If it is required to file a US tax return
  • Collect personal identification information and request to fill out W-8BEN (for individuals) or W-8BEN-E (for entities)
  • No need to report payments made by filing 1099 and 1096 to IRS
• If it is not required to file a US tax return
  • Find out if there is any reporting requirement in the country of incorporation
  • Find out if an independent contractor did any work within US borders and if any reporting to US is required.

7. Must-have clauses in an independent contractor agreement to prevent risks and losses to the company

Having a solid written agreement is crucial when you hire an independent contractor. A well-drafted contract can save you a lot of money and trouble in the future. The agreement should clearly state the scope of services and compensation. It should also indicate the contractor’s independence and the hiring company’s lack of control regarding how the contractor performs the work.

Additionally, a typical contractor agreement contains:

• Confidentiality and/or non-disclosure clauses to protect the company’s information from disclosure or misuse by contractors.
• Indemnity clauses to protect the company from being liable for any violation or infringement by a contractor.
• Intellectual Property Transfer clauses to transfer copyrights from a contractor to the company. In the US, independent contractors own the rights to the work done for the principal, unless it is transferred in writing. In some countries, certain intellectual property rights stay with creators and cannot be transferred, even in writing. International independent contractor agreements should reflect local laws related to intellectual property ownership.
• Notice clause —Too often, contractor agreements mirror at-will employment agreements, where either party can walk away at any time, without reason or notice. It could result in interruptions in business if the company relies on contractors for important tasks. Include a clause that requires a written notice in advance by either party terminating an agreement.
• Dispute resolution clauses are about resolving disputes when they arise. Parties can also choose to have alternative dispute resolutions, such as mediation or arbitration, instead of lengthy litigations.

8. Bonus: What if the entrepreneur has not incorporated yet and wants to hire an independent contractor?

Unincorporated sole proprietors and self-employed taxpayers can hire independent contractors for their regular and normal business activities as well. The same precaution is necessary to make sure the contractors are not considered as employees under the laws and the work relationship should be documented in the written agreement.

The same tax reporting rules in the above section 6 applies for an individual entrepreneur. He/she has to report payments to US contractors by filing 1099s to IRS.

Check out the Ultimate Guide of Hiring A Foreign Independent Contractors if you want to find out more about this topic.

Send an e-mail or schedule a call with Jiah Kim & Associates to find out how we can help you avoid the legal risks of hiring independent contractors.

This blog post is written for educational and general information purposes only, and does not constitute specific legal advice. You understand that there is no attorney-client relationship between you and the blog publisher. This blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.

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