Trends

6 Tips to Help Your Small Business When Using Independent Contractors

Brandy Haight Brandy Haight

Smiling Black female business owner textile industry green shirt

A recent joint industry research report between Worldwide Business Review (WBR) Insights and WorkMarket by ADP® identified that 71% of small businesses surveyed plan to increase their use of independent contractors (1099 workers, freelancers) within the next year.

The report found that this trend is primarily being driven by three factors:

  • The need for access to specialized skill sets
  • A desire for a more agile workforce that can scale up or down as needed
  • Cost savings associated with different benefit requirements

Despite the desire to grow their usage of contractors, small businesses often lack efficient and scalable processes for managing this growing workforce. In fact, 38% of small business responders had to reprioritize projects due to inefficiencies in managing contractors. Furthermore, most small businesses surveyed lack familiarity regarding the laws and regulations surrounding engagements with independent contractors. That's why we've compiled these tips to help small businesses optimize how they utilize independent contractors while mitigating compliance risks.

Tip #1: Always use a contractor agreement when onboarding new contractors

A contractor agreement is especially important for small businesses to help set clear expectations for both parties and for legal/financial protection. The agreement should outline the expected scope of work, confidentiality obligations, ownership rights over the work produced, payment terms, payment schedule, and provisions for managing disputes or damages that may emerge during the engagement. The agreement should also delineate the nature of the working relationship, clearly stating that the contractor operates on a per-project basis or for a specified time frame rather than as an employee. This can help mitigate worker misclassification risks as well.

In New York, businesses must now enter into written agreements with any contractor providing at least $800 in services rendered*. With this law, New York-based employers must furnish their independent contractors with a physical or electronic copy of the required written agreement and keep a copy of the agreement for six years. Employers may face fines of up to $25,000 if an independent contractor files a complaint within the 6-year period and is found guilty of violating the law. This law may be a harbinger of what's to come in other states.

Tip #2: Your traditional payroll platform may not be enough

Traditional payroll platforms geared towards full-time employees usually adhere to a payroll cadence (e.g. once every two weeks). However, one of the best practices when working with independent contractors is being able to provide a payment on any frequency. Managing contractor payments and maintaining records, such as invoices, can be challenging if your business tries using its W2 payroll system. That is why many businesses have turned towards contractor management systems to pay their contractors via automated workflows once the assignment is complete. Fast, reliable pay is arguably the most important factor to retaining top talent.

Another reason to utilize a separate system to pay your contractors is that it can also help mitigate the risks of worker misclassification. The average payroll system lacks the flexibility to manage specific assignments, store invoices, and collect contractor agreements, whereas a system dedicated to managing independent contractors should have these features. Keeping this documentation separate from standard payroll systems can help mitigate classification risks.

Tip #3: Pay independent contractors quickly and flexibly

Our research revealed that about 53% of small businesses have difficulty paying their independent contractors on time. To help ensure that payments are delivered on time, payment terms (Net 15, Net 30) should be stipulated at the beginning of the engagement with the contractor. Usually, pay is delivered after the worker submits their invoice, but this can be a cumbersome process that involves timesheets, emails, and multiple systems. Consider streamlining how invoices are generated, and payment is made. Look for a solution that can automatically generate invoices on behalf of workers once the assignment is complete, and then automatically generate a payment based on pre-set terms.

When it comes to how you pay your contractors, offering different payment types, such as direct deposit, pay cards, or electronic payment options can greatly improve their experience. This flexibility shows that you value their preferences and contributes to a positive working relationship. It also, once again, can increase the chances of retaining high-performing workers for future assignments.

Tip #4: Create an invoice audit trail

Invoices are crucial for holding businesses accountable after contractors complete their assignments. Collecting and securely storing these invoices is essential come tax season too. Yet, many small businesses do not store contractor invoices in one system. Instead, they are often handled on an ad-hoc basis. As a result, it can be difficult to assess the cost of projects and contractors over time. This lack of visibility is not only a hurdle come tax time, but it also can be a detriment to making strategic business decisions. Instead, storing contractor invoices in a digital centralized repository that allows searches by different criteria like contractor name, dates, project type, etc. is ideal.

Tip #5: Standardize processes for tax filing

Businesses using independent contractors may need to file IRS 1099-NEC forms at year-end if they paid at least $600 to a contractor during the year. Furthermore, a recent IRS mandate has significantly changed the threshold for businesses to electronically file information returns (including Forms 1099 NEC). The maximum threshold for returns, originally 250 per year, has been lowered to just 10. With such a drastic decrease in this threshold, even small businesses that may only employ nine full-time employees and pay just one contractor a year will be impacted. Because of this, businesses may want to consider shifting to an entirely electronic process for filing year-end returns to help avoid unnecessary penalties.

To help ensure seamless year-end tax filing, it's important to collect and verify worker tax IDs and addresses during onboarding. As noted previously, creating an invoice audit trail is also recommended to help with accurate reporting (and will come in handy during IRS audits). Abiding by best practices can help significantly reduce the administrative burden.

Tip #6: Leverage technology to efficiently manage your contractors

Adopting an independent contractor management system can be essential for small businesses aiming to improve operations while minimizing risk. The platform, WorkMarket by ADP®, streamlines processes from onboarding to paying contractors, including verifying US worker tax IDs, addresses and bank accounts to facilitate payment and tax filings. The solution also collects and stores company-mandated documents like contractor agreements, NDAs, and licenses to help ensure that contractors meet your requirements, as well as allowing workers to choose how they'd like to be paid and automated invoicing when assignments are completed. This helps workers to be paid on time and provides businesses with an audit trail. Come tax season, WorkMarket furnishes and electronically files all 1099-NEC forms with the IRS and any pertinent state agency.

Learn more about how WorkMarket can help with independent contractor management in a self-guided demo.

*Note the $800 threshold could be either by itself or when combined with other contracts for services between the same hiring party and freelancer during the preceding 120 days. This does not apply to services provided by attorneys, construction contractors, licensed medical professionals, or sales representatives.

The information and services WorkMarket provides should not be deemed a substitute for the advice of any such professional. Such information is by nature subject to revision and may not be the most current information available.