When hiring an Independent Contractor, certain details should be discussed and documented ahead of time. This is important to avoid disputes later on and to ensure that an Independent Contractor is not considered an employee by the IRS.
Why you need a written contract
For many of the projects that you would hire an independent contractor for, there is no legal requirement to have a written contract. But that doesn’t mean you should rely on just a verbal contract. There are many reasons why you should insist on a written agreement/contract. Verbal agreements usually lead to misunderstandings. There isn’t a clear understanding of what the contractor has agreed to do, what you have agreed to pay, when the job needs to be completed, how to handle change orders, or how to settle any disputes. Although some misunderstandings may be innocent, they may also be intentional. It will be your word against the contractors. Who will the judge believe? It’s much safe and usually less costly to use a written contract that details the terms of the job.
- A written contract is something you can’t afford to do without. A well written contract can be used as a reference in case you and the contractor disagree at some point.
- Many verbal agreements are binding and legal. However, they may not be in your best interest.
- A written independent contractor agreement helps establish a worker’s independent contractor status. It demonstrates to the IRS that both you and the contractor intend to create a client/independent contractor relationship, not an employer/employee relationship.
- However, a written agreement is useless if you treat the contractor like an employee. Here are some tips of what to include in your contract (and behavior) to ensure the Independent Contractor Agreement is held up by the IRS.
Important Terms to Include in Your Written Agreement
Title the Agreement or Contract as Independent Contractor Agreement. Make sure that you don’t use the word employment or employee anywhere in the Agreement.
Specify that the contract is between you/your business/community association and the independent contractor. Make sure that the contractor’s address is their place of business and not the job site.
Scope of Work: a detailed description of the services the contractor will perform
Include items such as what the contractor is supposed to do, milestones and dates, and the requirements for each milestone.
DO NOT specify how the work will be done. You need to ensure that you include that you agree on the finished product, but you can’t specify HOW it will be done.
Include detailed specifications of what will constitute an acceptable finished product. (This clause can also be an attachment to the contract.)
Here are two examples:
- Bad specifications: Contractor will perform website services for client.
- Better specifications: Contractor will develop a website using software X that will interface with client software Y. Review schedules/dates, and the exact fields, images, data, links, plugins to be included, are specified in Attachment A of this agreement.
Include a statement that the contractor has all of the state required permits and licenses to do the work
Include a statement by the contractor that he/she carries liability insurance
Revisions and Changes
As the client, you may want to include the following points:
- The Client is entitled to two revisions within the original scope of the contract, at no extra charge.
- The Client will compensate Contractor for additional revisions at an hourly rate of $x or a flat fee to be negotiated.
- Revisions outside the original scope of the project (as defined in the Scope of Work clause) will be negotiated separately.
If the contractor will need to rely on certain input from you, they may specify that any delay in receiving this input, will affect your deliverable items or dates. They may also stipulate that an extended period of non-responsiveness is grounds for them to terminate the contract. Be aware of this.
If the project is long and it includes review periods, the contractor may also specify the following – Be aware of this:
- The name of the person to whom they’ll deliver the work and who has the authority to accept or reject it (they want to make sure this person signs off on every review).
- The time in which the reviewer must accept or reject the review.
- Work submitted for review will be considered accepted, unless it’s rejected in writing within the time period specified. In the rejection notice, Client will clearly spell out all changes required.
Payment and Terms
Include in the contract what they will be paid and when they will be paid. If they are being paid a flat fee for the project, they may ask for 1/4 of the total fee upfront. If it’s a very long project, they may want 10 or 20 percent or more upfront and another 10 to 20 percent every month.
Usually, they will only agree to payment at the end of the project, when completing a very short project. If the contractor needs to order major parts, they will usually ask for a deposit when the parts are ordered and the balance when it is delivered to your site. Include an explanation of who will be responsible for expenses (true contractors usually pay their own expenses and include it in the total project cost)
If the contractor will be paid on the basis of a unit of time, specify what that unit is (hourly, weekly, monthly). Also include how often they will submit an invoice-weekly, monthly, etc. Be aware that the IRS is more likely to question their independent status if they bill based on a unit of time, rather than on a flat fee.
Independent Contractor Status is Very Important
The independent status concept establishes to the IRS that the Contractor is not an employee of the company/community association. If the IRS decides that the relationship is employer/employee instead of client/contractor, it will affect both of you.
To start with, the client will be responsible for back employment taxes and penalties. An employer is required by law to withhold (and pay) certain taxes on behalf of their employees. The contractor, will have to amend their income tax returns for the period covered by the contract. The contractor will be subject to additional taxes mainly because they will lose the right to deduct their business expenses for that project.
Clearly state their independent status with this statement “Contractor is an Independent Contractor and is not an employee of Client.” This is extremely important.
Other items that also establish the contract as independent and should be included:
- Control: Contractor has sole discretion to determine how, when, and where to perform services required to achieve the final result specified in the Scope of Work clause.
- Non-exclusive: Contractor has right to perform services for other clients during the term of the contract.
- Assignment: Contractor has the right to use employees or subcontractors to perform some or all of the duties required. However, the Client has the right to approve subcontractors or employees who perform significant services.
- Taxes: Client will not withhold any income or FICA/Medicare taxes from any payments to Contractor. Contractor is responsible for paying all applicable state, federal, and local income taxes.
- Insurance: Client does not provide workman’s compensation or unemployment insurance for Contractor or his employees.
- Benefits: As an independent contractor, Contractor is not eligible for and has no claim to medical benefits, profit sharing, vacation pay, sick pay, or other benefits offered by Client to employees.
- Expenses: Contractor is responsible for expenses and materials necessary to perform services required in Scope of Work. However, if the contractor meets the other independent status conditions, they can stipulate that the client will reimburse them for certain large expenses.
- Training: Client will not provide training to Contractor or employees or subcontractors of Contractor.
Terms of contract and termination and more
Other important items to include and identify are:
- When does the contract begin and end?
- Under what circumstances can either party terminate the contract before that end date?
- What obligation does the terminating party owe to the other?
- Job site cleanup at the end of every day
- Trip hazards – avoid them
- Required insurance such as liability and workers compensation insurance. Request to be an “additional insured” on their policy – you will be notified when they stop paying the insurance premiums
- Insurance indemnity
- Address of the job site
- Allowable hours to work/hours to avoid
- Permits and Inspections – they should be responsible for handling this
The scope of the project should dictate the term. Don’t make the term too long — it may then be considered an employer/employee relationship. For a long project, you could specify a certain term with the option to renew.
Usually, the termination of a contract is for cause — there’s a reason for terminating it before the end date. If you don’t include a reason, it can look like an employee relationship. You should include the reason, which may include the following:
- Breach of contract: If either party does not fulfill their obligations under contract, the other party should be able to terminate immediately without further obligation.
- Any business reason: For greatest flexibility, you can specify that either party can terminate the contract for business-related reasons, which essentially means any reason. Specify a minimum 30-day period of notice to avoid them looking like an employee.
Kill fees – Usually included by the contractor
If they are working on a project for a set fee, they may stipulate a “kill fee” for early termination. For example, if the client terminates the agreement in the third month of a six-month project, you may be obligated to pay them half of your total contract price, less any amounts you may have already paid them. Be aware of this.
Standard legal wording
The following points should be included in any contract as standard legal terms.
- Exclusive agreement: This is the complete and only agreement between Contractor and Client. (You may want to stipulate that any modifications to the contract must be in writing, signed by both parties, and attached to the original agreement.)
- Liability: What are the limits of liability for you and the client? Try to limit your total liability to no more than their compensation for the project.
- Resolving differences: Specify resolution of disputes. You may want to specify that mediation is to be pursued prior to litigation. You may also want to consider who pays legal expenses.
- Applicable law: What state’s law will govern the agreement? Usually, this is simply the state where you and the contractor do business.
- Confidentiality: The client has a right to expect that the contractor will keep certain private information confidential.
- Work-for-hire: This clause is to assure the client that the client will own the work the contractor does for them. They do this by defining the work they produce under the agreement — whether it’s a website, a set of training materials,etc — as a work-for-hire: The client will retain title and rights to the work the contractor creates for client.
- No partnership: State that neither party has the authority to enter into agreements on behalf of the other party.
- Notices: Are notices to be delivered in person (to whom?), in the mail, via e-mail? Basically, what constitutes a notice as considered being delivered?
- Enforceability: State that if any one clause of the contract is found to be unenforceable, all other clauses remain binding as they are.
Final Lien Waiver – Require after Punch List has been completed
- Clarifies that full payment has been made.
- Everyone is satisfied
- The contractor has paid all his employees/subcontractors in full
- Releases client/community association from any claims/liens (including Mechanics Liens)
This contract is for both you and the contractor. If you need to add additional clauses, you can add them. However, some clauses may not be legally enforceable, even if you both agree.