If you’re hiring independent contractors in the U.S., this guide will help you understand and control their legal status, tax obligations, benefits, and how to stay compliant.
Before diving into the details, here are some essential terms used throughout this article:
| Term | Description |
| Independent contractor | An individual who provides services to a company under a contract but isn’t considered an employee. They pay their taxes and don’t receive employee benefits. |
| Self-employed | A general term for anyone working for themselves, including freelancers, independent contractors, and small business owners. |
| Freelancer | A person who takes on project-based work for multiple clients, often in creative or technical fields (e.g., designers, copywriters, programmers). They may operate as independent contractors or as sole proprietors. |
| Gig worker | Someone who performs short-term, task-based jobs (gigs), often through digital platforms like Uber and DoorDash. Their work is typically transactional and platform-dependent. |
| Sole proprietorship | It is the simplest type of business – one person runs it and is fully responsible for its debts. |
| Partnership | A business structure where two or more people run a business together and share ownership, profits, and responsibilities for debts. |
| Limited Liability Company (LLC) | A business structure that protects its owners (members) from personal liability and offers flexible tax benefits. It’s a popular choice for self-employed professionals. |
As you can see in the table, not all self-employed individuals work the same way. Now, let’s look at how working with independent contractors works.
What is an independent contractor?
The Internal Revenue Service (IRS) defines independent contractors as individuals who control how they do their work, while the hiring company only decides on the final result. Independent contractors sometimes set their schedules, choose clients, and use their own tools or equipment. Because of this, they are responsible for handling their taxes and benefits.
Independent contractor vs. employee
The biggest difference between an employer-employee relationship exists between an independent contractor and an employee controls. Employers decide how, when, and where employees work. They also provide benefits, follow labor laws, and withhold taxes from paychecks.
Independent contractors, on the other hand, work on their terms. They choose their schedules, clients, and tools. Some independent contractors may work for multiple businesses in a year.
Others stay with the same company long-term but still maintain their independent contractor status. The key factor is whether the business controls how the work is done or just the final result.
Misclassifying an employee’s status as an independent contractor can lead to serious legal and financial penalties. The IRS uses the Economic Realities Test to determine worker status.
Economic Realities Test
The IRS and the U.S. Department of Labor use the Economic Realities Test to decide whether someone is an independent contractor. The main question is: is the worker economically dependent on the company, or are they running their own business?
To make that decision, several factors are considered:
- Profit or loss – Can workers make business decisions (like setting rates, accepting or declining work, or hiring help) that affect their earnings?
- Business investment – Does the worker invest in their own tools, materials, or business growth (like marketing or expanding their client base)?
- Work relationship – Is the work temporary or project-based rather than ongoing or permanent?
- Control – Does the worker control how the work is done without being micromanaged by the company?
- Role in the business – Is the work something the company depends on daily, or is it an extra service that’s not part of their core operations?
- Skill and initiative – Does the worker bring specialized skills and use them independently to grow their own business?
No single factor decides the outcome – what matters is the whole picture. Even if someone has a contract, they might still be classified as an employee if they depend too much on one company and don’t control how they work.
Risks of misclassifying an independent contractor
Misclassifying an independent contractor as an employee – or vice versa – can lead to serious legal and financial consequences for businesses. The Internal Revenue Service (IRS) and the U.S. Department of Labor (DOL) actively monitor worker classifications to make sure businesses follow tax laws and Fair Labor Standards Act (FLSA) regulations.
Consequences of misclassification
If a business misclassifies a worker, it may face:
- Financial penalties – the IRS may impose fines and require the company to pay back taxes, including Social Security and Medicare taxes that were not withheld.
- Unpaid benefits – workers may demand benefits such as health insurance, unemployment insurance, and workers’ compensation, which are required for employees.
- Legal disputes – misclassified workers can file lawsuits for unpaid minimum wage, overtime pay, or benefits.
- Government audits – the IRS, Department of Labor, and state labor departments may audit the company, which can result in further penalties.
How to avoid misclassification
- Follow the Economic Realities Test to determine if a worker qualifies as an independent contractor.
- Use a clear written contract to define the scope of work and the contractor’s independence.
- Ensure the contractor controls their work, schedule, and owns their equipment.
- Consult a tax professional or legal expert if unsure about worker classification.
Wrong worker classification can cost you. Do it right to avoid legal and financial trouble.
Independent contractors vs. freelancers, gig workers and more
Independent contractors, freelancers, and gig workers all fall under the category of self-employed individuals, legally entitled but their work structures, legal responsibilities, and income sources differ. Understanding these differences helps you handle contracts, taxes, and compliance more easily.
While all freelancers and gig workers are independent contractors, not all contractors fit these categories. Freelancers typically provide specialized, project-based services (e.g., writers, designers, developers), often working with multiple clients. Gig workers, on the other hand, take on short-term, on-demand jobs through platforms like Uber and DoorDash.
Look at this table to compare the most common types of self-employment and business structures in the U.S. You’ll see key differences in taxes, liability, and payment methods.
| Type of work | Formal business structure | Income Tax | Legal liability | Form of payment | Control over work | |
| Independent contractor | Contract-based work for companies | ❌ | Self-reported (Form 1099) | Personal | *Typically invoice or bank transfer | High control over work, within contract guidelines |
| Self-employed | Any self-employed activity | ❌ | Self-reported | Personal | Invoice / depends on structure | Full control over work and business operations |
| Freelancer | Creative work/project-based | ❌ | Self-reported | Personal | Project-based contracts | Full control over work execution |
| Gig worker | Short-term tasks | ❌ | Self-reported | Personal | Platform-based payments | Limited control; follows platform policies |
| Sole proprietorship | One-person business | ✅ | Taxed on owner | Personal | Business income | Full control but with financial liability |
| Partnership | Business with partners | ✅ | Taxed on partners | Partners | Profit sharing | Shared control, depends on partnership agreement |
| LLC | Limited liability company | ✅ | Option to tax on LLC or owners | Limited | Salary + dividends | Owners have operational control but follow legal requirements |
*Independent contractors typically receive payments through invoices and bank transfers, sometimes checks, or freelance platforms, but the exact method depends on the agreement with their client.
Examples of independent contractors
Independent contractors bring specialized skills to businesses on a project or contract basis, all while staying in control of their schedules, methods, and tools. Businesses hire them for their expertise without long-term commitments. Here’s how they work across different roles:
- Project-based consulting – experts in business, finance, and marketing provide strategic guidance based on defined goals.
- Service providers – accountants, tax specialists, and legal professionals offer compliance and advisory services.
- Creative professionals – writers, graphic designers, and video producers create content with full autonomy over their processes.
- Tech specialists – software developers and IT consultants build solutions using their own tools and methodologies.
- Administrative and support roles – virtual assistants and customer service providers handle operational tasks independently.
- Education and training providers – coaches and trainers design and deliver specialized programs.
Why hire an independent contractor?
Hiring independent contractors is a great way to save money, stay flexible, and bring in specialized skills when you need them.
Benefits of hiring independent contractors
- Save money – you don’t have to pay payroll taxes, health insurance, or retirement contributions. Independent contractors take care of their own taxes and benefits, which helps you cut costs.
- Stay flexible – you can scale your team up or down depending on project needs. There’s no need to keep a full-time employee when the workload changes.
- Get specialized skills – independent contractors bring expertise that you might not need all the time. This is perfect for short-term projects that require niche knowledge.
- Less paperwork – you don’t have to handle payroll taxes, unemployment insurance, or benefits. This makes compliance and HR management much easier.
Independent contractors offer great benefits, but remember – correctly classifying your workers as independent contractors is key to avoiding legal trouble.
Paying for independent contractors
When you hire an independent contractor, ensure you handle payments correctly. Unlike employees, contractors take care of their own taxes and benefits. You don’t need to withhold payroll taxes or offer perks like health insurance.
Here are some of the most common ways independent contractors charge for their services:
- Hourly or daily rates – some contractors track their time and charge per hour or per day, especially for ongoing projects.
- Fixed project fees – many contractors prefer a set price per project, no matter how long it takes. This is common in creative work, consulting, and development.
- Per unit of work – in some fields, contractors charge per deliverable, like per word (writers), per design (graphic designers), or per consultation (coaches and consultants).
- Retainers – a contractor may charge a recurring monthly fee for ongoing services. For example, a business might pay a marketer or legal advisor a set amount each month for specific hours.
- Upfront or partial payments – some contractors, especially when working with new clients, request a deposit before starting work.
Most contractors send invoices that outline the service provided, total cost, and payment deadline only the result. Discussing payment details upfront helps avoid confusion and ensures smooth collaboration.
Tax forms and compliance
When paying independent contractors, you must follow IRS rules to stay compliant. Here are the key tax forms you should know about:
- Form W-9 – always ask the contractor to fill out a W-9 form before making any payments. This form provides their taxpayer identification number (TIN) for tax reporting. Keep this form in your records for at least four years in case of any future inquiries from the contractor or the IRS.
- Form 1099-NEC – if you pay a contractor more than $600 in a year, you must send them a 1099-NEC form by January 31 of the following year. You need to send this form to both the contractor and the IRS.
- Form 1096 – if you file 1099-NEC forms on paper, you must also submit Form 1096 to the IRS. This form serves as a summary of all the information returns you’re filing.
Since independent contractors handle their own taxes, you don’t withhold Social Security, Medicare, or income tax from their payments.
Paying international contractors
Paying contractors in different countries takes a little more planning, but with the right approach, it’s simple. Here’s what you need to consider:
- Rates vary by country – contractors set their rates based on their living costs and market conditions in their country. It’s important to agree on pricing upfront to avoid misunderstandings.
- Choosing the right payment method – bank transfers, Wise, and PayPal are standard options, but some contractors may prefer local payment solutions.
- Currency exchange rates & fees – if you’re paying in a different currency, keep in mind that exchange rates and transfer fees can affect the final amount the contractor receives.
Paying international contractors doesn’t have to be a hassle. The right payment method and smooth invoicing can save time and keep everything compliant. Useme makes it easy to pay contractors securely and in their preferred currency.
Formal requirements for working with independent contractors
Hiring independent contractors is easier than hiring employees, but there are still a few important steps to follow. Clear agreements and proper documentation help you avoid legal risks, prevent misclassification under the Fair Labor Standards Act (FLSA), and stay compliant with IRS regulations.
1. You need a written contract
A written contract is essential when working with an independent contractor. It defines the independent contractor relationship and protects both the employer’s business and the contractor. A strong independent contractor agreement should include:
- Scope of work – a detailed description of services provided, deadlines, and deliverables.
- Payment terms – how the money paid will be structured (hourly, per project, or retainer).
- Right to control – clarification that the contractor maintains control over how the work is performed.
- Confidentiality & non-disclosure – if the contractor handles sensitive business information, include a clause for protection.
- Intellectual property rights – define who owns the work created. Without a clear agreement, the contractor may retain rights to their work.
- Termination terms – conditions under which the contract can be ended early.
2. Check their business license, insurance, and TIN
Certain industries require independent contractors to have:
- A business license – required for contractors in legal, financial, and construction industries.
- Own insurance – many business owners require contractors to have liability or professional indemnity insurance.
- Taxpayer Identification Number (TIN) – businesses must request Form W-9 to obtain the contractor’s TIN for tax reporting.
3. Keep records of payments and agreements
Even though businesses don’t need to withhold taxes for independent contractors, they must:
- Issue Form 1099-NEC for payments over $600 per year.
- Track employment tax compliance, ensuring the contractor files their self-employment tax.
- Keep records of business expenses, invoices, and payment receipts for IRS audits.
4. Consider local governments and international differences
Hiring independent contractors from different local governments or from outside the U.S. requires additional considerations:
- Follow local labor laws – some countries have stricter worker classification rules.
- Use international payment platforms – consider fees, taxes withheld, and payment timelines.
- Confirm eligibility requirements – some international contractors must complete Form W-8BEN to confirm non-U.S. tax status.
How Useme helps
Managing payments and contracts for independent contractors can be time-consuming and complex. Useme simplifies the process by providing a secure and efficient way to handle freelancer payments, ensuring compliance and ease of use for both businesses and independent contractors.
Why Useme is a great solution:
- Pay freelancers securely – we make sure freelancers get paid on time while keeping your business protected.
- No more admin hassle – forget about formalities like signing contracts or gathering data for the agreement.
- Smooth international payments – easily pay contractors in different countries without worrying about their preferred currency, without the hassle of exchange rates and transfer issues.
- Secure and reliable contracts – we provide a transparent contract that protects your interests, enforces deadlines, and ensures freelancers meet all agreed terms, so your projects run smoothly.
- Contracts made simple – we ensure your freelancers deliver the right tax forms. Our secure contracts protect your business and help your projects run smoothly.
Useme allows companies to work globally with freelancers and independent contractors while keeping financial processes streamlined and compliant. Plus, on Useme Jobs, you can find verified freelancers ready to work on your projects.
Conclusion
Independent contractors provide businesses with flexibility, cost savings, and specialized expertise. However, companies must properly classify workers, follow IRS tax regulations, and comply with labor laws to avoid fines and legal disputes.
Key takeaways:
- Independent contractors are not employees. They manage their taxes, benefits, and work schedules.
- Misclassification can lead to serious legal and financial consequences. Businesses should follow the Economic Realities Test and IRS guidelines to determine worker status.
- A well-structured contract is essential. Defining project scope, payment terms, and intellectual property rights protects both parties.
- Tax compliance is the responsibility of both the contractor and the business. Employers must issue Form 1099-NEC for payments over $600, while contractors must pay self-employment tax.
- International contractors require additional considerations. Companies should check local labor laws and tax requirements, and use secure payment methods.
Working with independent contractors doesn’t have to be complicated. → Create a free account on Useme and streamline your payments easily!
