Independent contractor or employee: what the agreement should cover

Why the label matters

Whether someone is a contractor or an employee decides who pays payroll taxes, whether overtime and minimum wage apply, and who carries insurance and benefits. Treating an employee as a contractor can lead to back taxes, penalties and claims for unpaid wages.

How classification is decided

The facts decide, not the title in the contract. Agencies and courts look at how the relationship actually works.

• Behavioral control: does the business direct how, when and where the work is done?
• Financial control: does the worker use their own tools, bear business risk and have a chance of profit or loss?
• The relationship: is the work ongoing and central to the business, or a defined project?

The IRS, the Department of Labor and state agencies each apply their own tests. Several states, including California, Massachusetts and New Jersey, use a stricter test for many wage laws that presumes a worker is an employee unless the business proves otherwise.

Signs of a genuine contractor

• They run their own business and have other clients.
• They set their own hours and methods.
• They provide their own tools and workspace.
• They are paid per project or by invoice.
• They can hire helpers or substitutes.

What the agreement should cover

• Scope: the services and the deliverables, in specific terms.
• Payment: the rate or fee, when invoices are due and how expenses are handled.
• Term and ending the agreement: the length, and how either side can end it.
• Independent status: the contractor controls how the work is done and handles their own taxes and insurance.
• Ownership of the work: who owns the result. An explicit assignment is safer than relying on the idea of work made for hire, which only fits certain kinds of work.
• Confidentiality: how each side handles private information.
• Liability and insurance, if relevant to the work.

Businesses generally must report payments to contractors above an IRS threshold on Form 1099-NEC. The threshold has changed recently, so check current IRS guidance.

Common mistakes

• Calling someone a contractor while directing their schedule and methods like an employee.
• Leaving the scope open, so the project grows without a price change.
• Not saying who owns the finished work.
• Having no written agreement at all.