Require Documentation When You Hire Independent Contractors

If you hire independent contractors (ICs), you must be vigilant to ensure that government agencies never reclassify them as employees -- which could subject you to back taxes and penalties. That vigilance must begin even before an IC walks in the door. If you plan to hire an IC, here are two things you can do to make sure you get the relationship off on the right foot.

Independent Contractor Questionnaire

When you meet with a prospective IC for the first time, you should have the IC complete an independent contractor questionnaire. Design this questionnaire to elicit the sort of information that will establish that the IC is a separate business entity, not just an employee in IC's clothing. You'll want to know:

• whether the IC has a fictitious or assumed business name
• how the IC's business is structured (as a sole proprietorship, partnership, corporation, or limited liability company, for example)
• the IC's business address and phone number
• the number of people employed by the IC, if any
• any professional or business licenses the IC holds
• contact information for other companies for whom the IC has worked as an independent contractor
• how the IC markets his or her business (for example, Yellow Pages, advertising)
• whether the IC has an office separate from his or her home
• a description of the business equipment and facilities the IC owns
• whether the IC has business cards, professional stationery, and invoice forms, and
• a list of all of the types of insurance that the IC carries.

None of the answers to these questions will provide conclusive evidence that a worker is an employee or an IC. But taken together, this information will help you decide whether the worker is an independent businessperson whom you can safely treat as an IC.

Warning - Employment applications are for employees, not independent contractors. Don't ask an IC to complete one of your standard employment applications. Government agencies may use this as evidence that the IC is actually your employee. Make sure the term "independent contractor" appears prominently in the title of your questionnaire, to avoid any possible confusion.

Gather Documents

Ask the IC to provide documents that will enable you to establish that the IC is a separate business entity, should the government ever decide to audit you. Make copies of all such documents and keep them in your files along with the questionnaire described above.

The documents you should request include the following:

• copies of the IC's business cards and stationery
• copies of any advertising that the IC has done, including advertising in the Yellow Pages
• a copy of the IC's White Pages business listing, if there is one
• if the IC is operating under a fictitious or assumed business name, a copy of the fictitious or assumed business name statement or application
• copies of any business or professional licenses
• certificates showing that the IC has insurance, including general liability insurance (and workers' compensation insurance if the IC has employees)
• a copy of the invoice form that the IC uses to bill for services
• if the IC rents business space, a copy of the office lease
• if the IC has employees, a document containing the IC's unemployment insurance number and Employer Identification Number
• copies of IRS Form 1099-MISC that other hiring firms have issued to the IC, and
• if the IC is a sole proprietor and will agree to hand them over, copies of the IC's tax returns for the previous two years showing that the IC has filed a Schedule C, Profit or Loss From a Business (which will show that the IC has been operating as an independent business).

Next Steps

Once you have reviewed the IC's questionnaire and documents, you will have to decide whether you can safely treat him or her as an IC -- or whether a government agency is likely to challenge that classification. For information on how government agencies decide whether a worker should be classified as an IC or an employee, see Independent Contractor or Employee: How Government Agencies Make the Call.

If you are satisfied that the worker qualifies as an IC, your next step is to create a written agreement detailing the terms of the project. For tips on drafting an agreement, see Put Your Independent Contractor Agreements in Writing.

If you have serious concerns that government agencies might classify the worker as an employee, you probably shouldn't court trouble by hiring the worker as an IC. Instead, you might consider hiring the worker as an employee -- or, you can thank the worker for his or her time and continue your search for a truly self-employed freelancer.

For detailed information working with independent contractors, freelancers and consultants, get Working With Independent Contractors, by Stephen Fishman (Nolo).