Can an LLC Hire an Independent Contractor?

February 28, 2023
Business Law

Startup businesses and small firms frequently find themselves needing more people in the early stages of operations. For limited liability companies (LLCs) with low cash flows and few benefits to offer yet, hiring independent contractors can seem like a good compromise. Before you do so, you should consider the benefits and detriments of hiring a contractor.

LLC Employee vs. Contractor

There are no rules that dictate whether an LLC can or cannot hire an independent contractor. What is important for the LLC owner to remember is the differences between an LLC employee versus a contractor. A small business has more at stake if they misclassify an employee as a contractor and are caught by the state or IRS.

A contractor is not covered by employment law

Under Maryland wage and employment law, an independent contractor is not granted the same protections and rights as an LLC employee. However, merely hiring a worker as an “independent contractor” does not automatically make them so under the law. If the relationship between the worker and the employer appears to be an employer/employee relationship, then the courts will tend to find it so.

How employees differ from contractors

If there are any questions about your employees or contract workers, investigators look at a number of factors that distinguish employees from contractors. These factors can include:

Financial status, such as who pays the payroll taxes, who pays for benefits, and who controls purchase of materials and tools. Financial status is the least important of the factors in determining status.
Contractual relationship, including employment agreements, pension plans and insurance. An independent contractor typically does not have any agreements with the employer that includes long-term benefits.
Control over work environment is the most important of the three. You may have agreed that your worker is an independent contractor, and they may pay their own taxes, but if you are the one who has final say over how the job is done, how many hours the worker spends on the job, and what tools or materials may be used, then the worker is more likely to be considered an employee.

Dangers of Misclassification

The reason an LLC needs to be cautious about hiring an independent contractor vs. hiring a regular employee is something called misclassification. Misclassification has to do with calling employees independent contractors in order to save money on payroll and other taxes.

Employees are entitled to worker’s compensation, income tax withholding, minimum wage and overtime payments, and other federal benefits. Independent contractors do not receive these benefits. By calling an “employee” a “contractor,” companies can save money. Sometimes contractors go along with this, since they get other benefits by not being an employee.

The recent rideshare legislation in California is an example of how businesses can turn contractors into employees. Uber and Lyft began as contract drivers for hire. Anyone could sign up and become an Uber or Lyft driver. Drivers accepted lack of benefits for complete freedom to drive when they chose.

As the companies began demanding that drivers provide certain types of vehicles, required background and health checks, and insisted drivers be available specific hours, the “contractors” became more like “employees.” The courts agreed. Rideshare companies and drivers had to make compromises between how much freedom contractors could have and how much control the companies could exert.

How Misclassification Hurts Businesses

Intentional misclassification can result in serious penalties for businesses, even if the contractors agree with the classification. The penalties can include having to pay back all the unpaid taxes, compensate the employee for unpaid wages, repay state worker’s compensation premiums, and other fines and fees.

For small businesses trying to straddle the line between compliance and profit, misclassifying your employees is a dangerous mistake to make. It is always better to consult a business attorney if you are uncertain about the status of your employees or contractors.

What Forms do I Need to Hire an Independent Contractor?

If you decide that independent contractors will help your business, you should do it correctly. The IRS website has the forms you need to hire your contractor and keep them in the right tax classification.

W-9 Form. This is the form contractors use rather than a W-2. The contractor will provide their Taxpayer Identification Number (TIN), which may be their Social Security Number or Employer Identification Number (EIN) if they have their own business ID. You’ll need to keep this for your own records for four years.
1099 Misc. The contractor will pay their own payroll taxes, but if you will be paying more than $600 in total payments, you need to file a 1099 Misc and provide a copy to the contractor for their records.
1096. This form lets the IRS know you completed the 1099 Misc and sent it to the contractor.
You should also check the state forms website. Maryland’s workplace fraud protections focus on landscaping and construction, and if your business is hiring such a contractor, you should see if any of their forms apply to you.
Finally, you should have a written contract that spells out the terms and conditions of the contractor’s work, what they will be doing, how they will be compensated, liability, and so on.

The default status of anyone who works for you is that of employee. The best way to protect your company and the contractor is to have a contract that explains your business relationship in very specific terms. If you’re not sure of the best way to do this, you should have a contract attorney write one for you or review the one you have for any ambiguities.

Contact Our Business Attorney Today

If you need a business attorney in the Frederick, Maryland, area, you need Lusk Law, LLC. We are advocates for all types of small businesses, and we know how to help you navigate the legal pitfalls of running a business. We are your Advocates For Life’s Obstacles and Opportunities no matter what they may be.

Contact us at Lusk Law, LLC or call us at (443) 535-9715.