Before You Hire a Consultant

Businesses regularly retain the services of consultants to work as an independent contractor for a specific project or service.

Whatever the circumstances that give rise to the need for a consulting relationship, there are two primary steps the business should consider before engaging a consultant.

First, the company must consider whether the individual is eligible to be an independent contractor, rather than an employee. This is not a question of preference, but a legal one. While there is not a single test that will clearly distinguish an employment relationship from a contractual one, criteria has been issued by the Internal Revenue Service, the Department of Labor, as well as federal and state courts, to help businesses comply with the requirements. Each agency sets out criteria that must be met for a person to be eligible to be a consultant, rather than an employee of the company. For instance, IRS utilizes a control-based test that looks at whether the business that is hiring the worker has the right to control or direct only the result of the work and not what will be done and how it will be done. The Department of Labor looks more to the economic reality and the extent to which the worker is dependent on the business. Courts have leaned toward looking at totality of circumstances in determining if the worker is an independent contractor or an employee:

  • The extent to which the services rendered are an integral part of the principal's business.

  • The permanency of the relationship.

  • The amount of the alleged contractor's investment in facilities and equipment.

  • The nature and degree of control by the principal.

  • The alleged contractor's opportunities for profit and loss.

  • The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.

  • The degree of independent business organization and operation.

Properly performing the analysis prior to engaging a consultant is an important step in managing the businesses’ risk exposure. Noncompliance with classification criteria is an expensive and messy proposition. In addition to substantial fines and penalties imposed by the agencies, back taxes, as well as benefits are often assessed.

Second, the company must put in place a comprehensive consulting agreement, also often referred to as an independent contractor agreement, that defines the parameters of the consulting relationship. An improperly drafted consulting agreement introduces unnecessary risk exposure. In drafting a consulting agreement, a company must strike the right balance between: (1) establishing the nature of the service, expectations regarding timing and quality of work, and compensation; (2) giving the consultant sufficient independence so that the company may properly classify him or her as an independent contractor rather than an employee; and (3) incorporating provisions that will account for and mitigate risk associated with the engagement. Businesses must carefully evaluate the need for protection of their confidential information, potential for creation of intellectual property, as well as their need for protection against the consultant competing with the company, or soliciting its employees, clients or vendors.

Many of the risks involved in engagement of consultants can be successfully eliminated or mitigated through proper planning, analysis, and documentation. Please do not hesitate to reach out to us if you would like help in understanding tests utilized by government agencies to determine if you are compliance with classification of your independent contractors, would like us to review or refresh your existing consulting agreement, or need a new one. We are here to help make your business a success.

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