Contractor compliance basics: What you need to know to reduce risk

Important disclaimer: This guide provides general information about contractor compliance. It is not legal advice. Employment and tax laws vary by jurisdiction and change frequently. Consult qualified legal and tax counsel for advice specific to your situation.

Contractor compliance isn't complicated, but it matters. Misclassify a contractor as an employee, and you face back taxes, penalties, and legal fees. Skip proper documentation, and you have no protection in disputes. Ignore intellectual property clauses, and you might not own the work you paid for.

This guide covers the basics: how to structure contractor relationships to reduce risk, what documentation you need, and common mistakes to avoid. It's practical, not exhaustive. For complex situations, consult counsel.

Classification: The fundamental question

The fundamental compliance question is: Is this person a contractor or an employee? Tax authorities care because employees trigger payroll taxes, benefits obligations, and labor law protections. Contractors don't.

Different jurisdictions use different classification tests (ABC test, IRS factors, economic reality test), but they all look at similar factors: control, independence, and the nature of the relationship.

Control: Contractors control how they work. You don't dictate work hours, location, methods, or tools. Employees don't have this control—they're told what to do, when, where, and how. If you set work hours, require a specific location, prescribe methods, or provide all tools, the relationship looks like employment. If the contractor decides when and how to deliver results, it looks like contracting.

Independence: Contractors work for multiple clients, use their own tools, and bear business risk. Employees work for one employer, use company tools, and receive steady pay regardless of results. The more independent the worker—working for others, using their own equipment, managing their own business—the more likely they're a contractor.

Relationship nature: Contractors work on project-based engagements with clear deliverables and end dates. Employees have ongoing, indefinite relationships. If the work is core to your business and ongoing indefinitely, it looks like employment. If it's specific projects with clear endpoints, it looks like contracting.

No single factor determines classification. Authorities look at the totality of the relationship. The more factors that point toward independence, the safer the contractor classification. You want the relationship to consistently demonstrate all three elements: contractor controls methods, contractor is independent, and the relationship is project-based.

Structuring relationships for compliance

How you structure the relationship matters as much as what you call it. Here's how to set up contractor relationships that withstand scrutiny.

Define work as projects. Structure engagements as specific projects with deliverables and end dates, not ongoing duties. "Design 5 website pages by October 15" is clearly project-based. "Handle all design work as needed" looks like an ongoing employment relationship.

Pay for results, not time. Milestone-based payments (50% on design approval, 50% on final delivery) reinforce contractor status better than hourly rates. If you use hourly rates, tie them to specific tasks, not open-ended availability. Hourly payment for indefinite work looks like employment.

Contractors use their own tools. Contractors should use their own equipment and software. If you provide a laptop, business email address, and software licenses, the relationship looks like employment. You can provide access to collaboration tools (Slack, Figma, project management) for communication and coordination, but not core work equipment.

No employee benefits. Contractors don't receive employee benefits like health insurance, paid time off, or retirement contributions. If you offer these, you're treating them like employees and undermine contractor classification. Keep this distinction clear.

Contractors work for multiple clients. Contractors should work for other clients. You can't require exclusivity. If a contractor works only for you for an extended period, the relationship starts to look like employment even if the initial setup was correct. Encourage or allow contractors to work for others.

Documentation you must keep

Good documentation protects you if the relationship is ever questioned. Keep these documents for every contractor.

Written contractor agreement. Always have a written agreement signed by both parties before work begins. The agreement should explicitly state the relationship is independent contractor, not employment. Include clauses on scope of services, payment terms, intellectual property ownership, confidentiality, and termination conditions. Verbal agreements don't protect you if someone questions the classification.

Statement of Work (SOW). For each project, create an SOW defining specific deliverables, deadlines, and payment. The SOW reinforces that the relationship is project-based with defined endpoints, not ongoing employment.

Invoices. Contractors should submit invoices for payment. Invoices show the relationship is business-to-business, not employer-employee. Keep all invoices with corresponding payment records.

Tax forms. Collect W-9 from U.S. contractors or W-8BEN from international contractors before the first payment. These forms establish tax status and are required for 1099-NEC reporting (U.S.) or withholding exemptions (international). Store these securely.

Deliverables and project records. Keep copies of all work delivered. This proves the contractor completed specific projects, not ongoing duties. Store deliverables with the corresponding SOW and invoices so you can trace the complete project.

Store all documentation centrally in one location for at least 7 years. If questioned by tax authorities, you'll need to produce these documents quickly.

Intellectual property and confidentiality

Without proper clauses, you might not own the work you paid for. Intellectual property and confidentiality provisions are essential in every contractor agreement.

Work-for-hire clause. Include a work-for-hire clause stating that all work product created by the contractor belongs to you. In the U.S., this is critical—without it, the contractor may retain copyright to their work. Example language: "All work product shall be considered a work made for hire and shall be the sole property of [Your Company]."

Assignment of rights. As a backup to work-for-hire, include an assignment clause where the contractor explicitly assigns all rights to you. This covers jurisdictions where work-for-hire doesn't apply automatically or provides additional protection.

Confidentiality and NDA. Include an NDA provision prohibiting the contractor from disclosing your confidential information to anyone. Define what's confidential (business plans, customer data, proprietary processes, trade secrets) and set a duration for the confidentiality obligation (typically 2-5 years after the engagement ends).

Non-compete (use carefully). Non-compete clauses are tricky with contractors. Overly broad non-competes can make the relationship look like employment. If you need one, make it narrow: limited to direct competitors, specific geography, and reasonable duration (6-12 months). In some jurisdictions, non-competes for contractors are unenforceable.

Have counsel review. For high-value work or sensitive projects, have an attorney review your IP and confidentiality clauses. Standard templates work for routine projects, but custom situations need custom language.

Communication and behavior

How you communicate with contractors and treat them matters. Language and behavior that suggest employment can undermine your classification, even with perfect contracts.

Avoid employee language. Don't call contractors "employees," "staff," or "team members" in emails or documents. Use "contractor," "consultant," or "vendor." Don't include them in employee-only communications, meetings, or events.

Focus on results, not methods. Tell contractors what you need and when, not how to do it. "Deliver 5 website pages by October 15" is fine. "Work 9-5 in our office using our design process" looks like employment because you're prescribing how they work.

Provide feedback on deliverables, not performance reviews. Don't conduct formal performance reviews like you would for employees. Review and provide feedback on the work delivered, but don't evaluate their work habits, punctuality, attitude, or other employment-like factors. That's employment behavior.

Respect independence. Don't require contractors to work specific hours, attend all meetings, or be available on demand. They should have flexibility in when and how they work. Close micromanagement and constant availability requirements suggest employment.

Train your team. Managers and team leads should understand these distinctions. A manager who treats contractors like employees can create classification risk, even if HR has perfect documentation. Make sure your team knows to maintain the boundaries.

International contractor considerations

Contractor compliance gets more complex with international contractors. Each country has its own rules, and some are stricter than others.

Country-specific tests. The U.S. uses IRS factors and the ABC test. The UK has IR35. Spain and Italy have strict anti-fraud rules for contractor arrangements. Research the classification test in the contractor's country, especially for long-term or high-value engagements.

Tax documentation. For international contractors working with U.S. companies, collect W-8BEN to establish foreign status and avoid withholding. Other countries have similar forms. Consult a tax advisor for multi-country contractor arrangements.

Local counsel for complex situations. For high-value or long-term international contractors, consider having local counsel review the arrangement. What's compliant in one country may not be in another. Local expertise reduces risk significantly.

Permanent establishment risk. In some countries, having contractors work for you regularly can create "permanent establishment," triggering corporate tax obligations. This is rare but possible. Consult tax counsel if you have multiple contractors in one country, especially if they work from your office.

Common compliance mistakes

No written contract. Verbal agreements don't protect you. Always have a written contractor agreement signed before work begins. It's your primary defense if classification is questioned. Email confirmation is better than nothing, but a formal contract is much better.

Treating contractors like employees. Requiring specific hours, providing equipment, conducting performance reviews, including in team events, or offering benefits all suggest employment. Maintain clear boundaries between contractors and employees.

Long-term exclusive relationships. A contractor who works only for you for years looks like an employee. If a contractor relationship becomes long-term and exclusive, consider converting them to employment or ensure they maintain other clients to preserve contractor status.

Missing intellectual property clauses. Without work-for-hire and assignment clauses, you might not own the work. Always include IP provisions in contractor agreements.

Inconsistent documentation. Missing contracts, invoices, or tax forms create risk. Keep complete records for every contractor for at least 7 years.

Poor communication about classification. If your team talks about contractors as employees or treats them as such, it creates evidence against contractor classification. Consistent language and treatment matter.

The bottom line

Contractor compliance isn't about perfection—it's about reducing risk through proper structure, documentation, and communication. Structure relationships to emphasize independence. Maintain proper documentation. Include intellectual property and confidentiality clauses. Communicate appropriately and consistently.

These basics cover most situations. For complex situations—long-term relationships, high-value engagements, international contractors in strict jurisdictions, or situations where classification is genuinely unclear—consult qualified legal and tax counsel. The cost of advice is far less than the cost of misclassification.

Get the fundamentals right: written agreements, project-based scope, results-based payment, contractor controls methods, contractor works for others, proper documentation. These reduce your risk significantly.

When in doubt, consult counsel. It's the prudent investment.