Independent Contractor and Consulting Agreements

Businesses can benefit from hiring independent contractors or consultants, rather than employees. However, you should carefully document the agreement with the independent contractor or consultant to avoid problems with the Internal Revenue Service. And if you contract with the independent contractor or consultant to develop a product, software, a book or manual, or other intellectual property, you need to document what rights you expect to retain in the end product.

In this guide we provide valuable forms and agreements to use when working with independent contractors and consultants. We also address the key business and tax issues that you are likely to encounter when dealing with independent contractors and consultants.

Advantages and disadvantages of working with independent contractors and consultants

There are certain benefits to contracting with independent contractors and consultants. Consider the following advantages:

• You get special expertise.
• You use them as needed.
• You save on tax contributions.
• You save on benefits.
• You have flexibility in the relationship.

However, there is a downside. Consider the following disadvantages:

• You run the risk of tax problems.
• You may not have the same continuity in the relationship that you would have with an employee.
• You may have to pay high fees to the contractor.
• You have limited control over the contractor.

Protecting your interests

Experience and qualifications

Before you hire an independent contractor or consultant, you may need background information to determine if he or she is the right person for the job.

Download our form which offers some questions that you may want to ask.

Then, if you want to verify the information you've been given, have the consultant or independent contractor sign a background check form such as the samples you can download here and here.

Independent contractor agreements

Your business must have a good form of agreement when independent contractors. A good agreement covers the following:

• Services to be performed: This part of the contract should carefully spell out the services to be performed. Make sure that you have spelled out all of the things you expect the independent contractor to do for his or her compensation.
• Timing: The contract should spell out when the services are to be performed. Also consider a late-penalty fee if the services are not performed on time, or a bonus if finished early.
• Payment: The payment clause of the contract should address the amount to be paid, the manner payment is to be paid (on an hourly basis? on a project basis?), and when payments are due. From the company's perspective, it wants to ensure that it's reasonably satisfied with the quality and scope of services rendered by the contractor before being obligated to pay the entire amount.
• Reporting: The contract can also address how often the contractor needs to report progress made, and to whom to report. Be careful here, because excessive control over the activities of the contractor may result in him or her being deemed an "employee" for tax purposes.
• Confidentiality obligations: The contract needs to make clear that the contractor must keep proprietary information about the company confidential and not use such information other than for the benefit of the company.
• Work for hire: The contract should typically provide that the work product developed by the contractor for the company will be deemed work for hire under the copyright laws and owned solely by the company (and not the contractor).
• Warranties: Spell out any warranties from the contractor, such as the contractor warranty that the services be performed in a high-quality, professional, and timely manner.
• Subcontractors: If the contractor expects to use any subcontractors, consider providing that you have approval over these subcontractors and that they execute an appropriate agreement with you.

Download a form which provides a sample Independent Contractor Agreement.

Download a similar agreement for consulting services.

Download a form which provides an agreement for professional services.

Confidentiality and Invention Assignment Agreements

You will want to consider having any consultant sign a confidentiality agreement. Consultants, especially if the business is technology-oriented, often have access to a considerable amount of the company's confidential information. You will also likely expect the consultants to come up with ideas, work product, and inventions useful to your business, and you will want to ensure that your business—not the consultant— maintains an ownership interest in any ideas, work product, or inventions developed by the consultant.

In areas where you are particularly sensitive about confidentiality and the company's ownership of the product developed, you should require consultants to sign a Confidentiality and Invention Assignment Agreement. This agreement deals with the confidentiality issue, but can also provide that the ideas, work product, and inventions the consultant creates in connection with services performed for your business belong to the company (not the consultant). This agreement is more detailed and protective than the Independent Contractor Agreement discussed in the preceding section. It is best used in conjunction with a Consulting Agreement, as in the example contained in Appendix E.

Download a form which shows a separate sample Confidentiality and Invention Assignment Agreement for Consultants. This form is extensive and pro-company-oriented.

Tax considerations

Tax laws allow you to treat employees and contractors differently. In fact, decreased tax liability is one of the greatest benefits your company can realize from using an independent contractor or consultant. You must be especially vigilant, however, to correctly fill out your forms and agreements to avoid having the IRS disagree with your assessment of a worker as an independent contractor.

Distinguishing between employees and independent contractors

The following table summarizes some key differences between independent contractors and employees. These issues directly affect your obligations and determine what forms you must fill out with respect to the worker.

For further information on determining who can be considered an independent contractor, refer to IRS Publication 15-A, the Employer’s Supplemental Tax Guide at www.irs.gov.

Your obligations as an employer

The IRS requires employers to do the following for each employee (but not for each contractor):

• Withhold income taxes and the employee's share of Social Security and Medicare contributions
• Pay the employer's share of the Social Security and Medicare contributions

If the IRS determines that a worker should have been classified as an employee, rather than an independent contractor, it can assess the following penalties (these are only the IRS penalties; other governmental entities—such as the State Employment Department or the National Labor Relations Board—may also impose penalties):

• Payment of federal income tax that should have been withheld from the employee
• Payment of Medicare contributions that should have been withheld
• Interest on taxes that should have been withheld
• A penalty for failure to properly file tax returns and pay taxes
• A larger penalty if the IRS determines that the behavior was negligent, intentional, or fraudulent
• Criminal sanctions, including imprisonment and fines up to $100,000
• Personal liability for corporate officers, up to 100% of the amount that the employer should have withheld from the employee's compensation

Tax forms used for hiring independent contractors

There are two key IRS forms that you need to consider when dealing with independent contractors: