About to hire a contractor? Learn key considerations for small business owners.

One of the first questions you might ask is, "Should I hire a contractor or an employee for my small business?" The answer depends largely on the level of control you need to exert over the work.

Employees typically work on a fixed schedule, follow specific company regulations, and use tools provided by the employer. In contrast, independent contractors are self-employed individuals who provide services under the terms of a specific contract. They generally manage their own schedules, provide their own equipment, and have the autonomy to decide how the work gets done.

Hiring independent contractors can offer significant cost savings because you do not have to pay for benefits or payroll taxes. Additionally, if they have their own workers' compensation insurance, you don’t have to pay for their coverage.

Accurately classifying your workers is critical for avoiding serious legal and financial consequences. The IRS uses a common law test that looks at behavioral control, financial control, and the type of relationship to determine worker status. Behavioral control refers to whether you have the right to direct how the worker performs the task. Financial control involves who provides the tools and whether the worker can realize a profit or loss.

If you exert too much control over these factors, the person may be legally considered an employee rather than a contractor. Hiring a contractor vs. an employee requires careful evaluation, as failing to classify someone correctly can lead to back taxes, penalties, and even lawsuits.

Beyond federal guidelines, individual states often apply their own regulations and tests to determine worker status for state taxes, workers' compensation, and unemployment insurance.

There are several tax implications of hiring independent contractors that every business owner should understand. Unlike employees, contractors are responsible for handling their own income tax withholding, Social Security, and Medicare taxes. However, you still have reporting responsibilities as the organization doing the hiring.

You should talk with your tax advisor if you plan to use contractors. Your advisor can explain your obligations.

For example, you are typically required to collect a completed Form W-9 from each contractor to verify their name, address, and taxpayer identification number. If you pay a contractor a significant amount over the course of a year, you will likely need to file Form 1099-NEC with the IRS to report those payments. Keeping thorough records of all invoices and payments is essential for smooth tax reporting.

You might also wonder, "What insurance do I need when hiring a contractor?" It is a common misconception that your existing business policies will automatically cover every person working for you.

So, does business insurance cover independent contractors? That depends on the situation. Consequently, it’s crucial to check the terms and conditions of the policy.

A key consideration is whether your partners have their own policies. Do independent contractors need their own insurance coverage? In most cases, the answer is yes, especially for high-risk work like construction.

You should require your contractors to carry their own general liability insurance to cover third-party injuries or property damage. If they don’t have coverage and a problem arises, you will likely be held liable for the costs. For example, if you involve a plumber in a bathroom renovation and a leak damages the property, the client may expect you to pay for the damage.

Additionally, contractors should have their own workers’ compensation insurance. Otherwise, your business could get charged for workers' compensation on the payments made to them. Also, if a contractor provides professional advice, they may need professional liability insurance or errors and omissions insurance to protect against claims of negligence.

At biBerk, we recommend that you always ask for a Certificate of Insurance (COI) before any work begins to ensure that your business is not left vulnerable.

Following a structured process can help you find the best talent and stay compliant. Developing a list of questions to ask before hiring a contractor can help you identify whether a candidate truly understands your industry standards.

Consider these best practices during your search:

• Define the project. Write a clear description of the tasks, goals, and deliverables so candidates understand exactly what you will expect from them.
• Screen candidates thoroughly. Review portfolios and check client testimonials to verify that the professional has the necessary skills and a history of reliability.
• Verify tax documentation. Be sure you have a completed Form W-9 on file before you issue any payments. This is crucial to stay compliant with IRS regulations.
• Confirm contractors have insurance. Ask each contractor for proof of insurance so you know that they can handle any potential accidents or mistakes.
• Set communication expectations. Agree on how you will stay in touch and how often you will review deliverables to maintain project momentum.

Once you find the right fit, you should always have a written agreement in place. This legal document serves to set expectations and protect both parties if a dispute arises. You should work with your legal advisor to create your contractor agreements.

In general, agreements should clearly define the scope of work, project timelines, and payment terms. It is also vital to address intellectual property rights to ensure that your business owns the work product once it is paid for. Including a confidentiality agreement or a nondisclosure agreement can help protect your sensitive business information. Finally, make sure there is a clear termination clause that explains how either party can end the relationship if necessary.

Protecting your business involves more than just managing your employees. You also need the right insurance policies to safeguard your assets. While you are considering how to hire a contractor and the insurance they should have, it is a good time to review the  coverage you have for your own assets and operations.

For example, most companies need General Liability insurance, which protects against lawsuits, such as from damage caused to a clients property. If you have employees, you are generally required by law to have Workers' Compensation insurance to cover their medical bills if they are hurt on the job. Based on the type of work you do, your business may also benefit from other coverages.

Professional Liability insurance is also crucial for companies that provide professional advice. If a client sues you, claiming your services caused them financial damage, this coverage can protect your business.

These are just a few of the business insurance policies you should consider.