What You Need to Know About Hiring a Contractor

Nellie Akalp is the CEO of CorpNet.com, an online legal document filing service, where she helps entrepreneurs incorporate or form an LLC for their new businesses. Connect with Nellie on Twitter or visit her free resource center.

The contract workforce is fast becoming the new normal. Independent workers now make up 30% of the nation's workforce, according to the Freelancers Union. Online employment middleman Elance is also experiencing record growth, hitting more than $500 million in total freelancer earnings since 2007.

The uncertainty in the economy undoubtedly drove many employers to hire freelance or contract workers in place of full-time employees. Along the way, many employers also quickly recognized the unique benefits of this approach, particularly that the cloud offers a vast pool of experts ready to pitch in at a moment's notice.

However, this new workforce dynamic carries tricky legal implications for employers. There's widespread misunderstanding about when an individual meets the legal requirements to be treated as a contractor versus a full-time employee. Here's what to consider.

The Difference Between a Full-time Employee and a Contractor

Whether a worker is an independent contractor or employee generally boils down to how much control is exercised by the employer. In other words, you can't force someone to work 9 a.m. to 5 p.m., but you can ask they work 20 hours a week. This is true even for part-time or short-term help.

For a more formal approach, the Small Business Association outlines the differences between contractor and employee as follows:

• An independent contractor: Operates under a business name, has his/her own employees; maintains a separate business checking account; advertises his/her business' services; invoices for work done; has more than one client; has own tools and sets own hours; keeps business records.
• An employee: Performs duties dictated or controlled by others; is given training for work to be done; works for only one employer.

The Consequences of a Misclassification Error

Misclassification errors are common. A 2000 Labor Department study (the most recent available) found that 10% to 30% of companies, audited across nine states, misclassified some employees.

If you make a mistake in classifying an employee as an independent contractor, you can be forced to pay back taxes and penalties for federal and state income taxes, social security, medicare, and unemployment. In addition, you may be liable to reimburse the worker for any wages you should have paid them under the Fair Labor Standards Act, such as overtime and minimum wage. And in some cases, you may be required to provide employee benefits, such as health insurance.

How to Stay out of Trouble When Hiring Contractors

The IRS is keenly aware that businesses have been downsizing full-time employees to independent contractors over the past decade. As a result, they have been cracking down on the misclassification of contract workers. However, this fact shouldn't deter you from taking advantage of the independent workforce. But you do need to be savvy when hiring independent contractors. Here's what to remember.

• Be sure to issue a Form 1099 for all independent contractors. This will be one of the first things an auditor will ask for.
• Be careful about the amount of control and supervision you exert over a contractor. For example, make sure your contractors can set their own hours.
• Hire independent contractors who have other clients, or who are actively marketing their services.
• Don't hire a contractor to perform the same service or duties as your company. For example, if you own a plumbing business, it's perfectly reasonable to hire a contract web designer. But hiring a contract plumber could raise a red flag.