Contractor compliance basics

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 IP 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: contractor vs employee

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

Different jurisdictions use different 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. Employees don't. If you dictate work hours, location, methods, or 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, 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, it looks like employment.

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.

Structuring compliant relationships

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

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

Results, not hours: Pay for deliverables, not time. Milestone-based payments (50% on design approval, 50% on final delivery) reinforce contractor status. Hourly rates are acceptable but should be tied to specific tasks, not open-ended availability.

Contractor's tools: Contractors should use their own equipment and software. If you provide a laptop, email address, and software licenses, the relationship looks like employment. Provide access to collaboration tools (Slack, Figma) but not core work equipment.

No 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, which undermines contractor classification.

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.

Essential documentation

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

Written contract: Always have a written contractor agreement. It should explicitly state the relationship is independent contractor, not employment. Include clauses on scope, payment, IP ownership, confidentiality, and termination. Verbal agreements don't protect you.

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, 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 payment records.

Tax forms: Collect W-9 (U.S. contractors) or W-8BEN (international contractors) before payment. These forms establish tax status and are required for 1099 reporting (U.S.) or withholding exemptions (international).

Deliverables: Keep copies of all work delivered. This proves the contractor completed specific projects, not ongoing duties. Store deliverables with the corresponding SOW and invoices.

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

IP and confidentiality clauses

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

Work-for-hire: 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. Example language: "All work product shall be considered a work made for hire and shall be the sole property of Company."

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

Confidentiality: Include an NDA provision prohibiting the contractor from disclosing your confidential information. Define what's confidential (business plans, customer data, proprietary processes) and set a duration (typically 2-5 years).

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).

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

Communication and behavior

How you communicate with contractors 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 or events.

Focus on results, not methods: Tell contractors what you need, 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.

No performance reviews: Don't conduct formal performance reviews like you would for employees. Provide feedback on deliverables, but don't evaluate their work habits, attendance, or attitude. 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. Micromanagement suggests employment.

Train your team on these distinctions. A manager who treats contractors like employees can create classification risk, even if HR has perfect documentation.

International 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. Research the classification test in the contractor's country, especially for long-term or high-value engagements.

Tax forms: 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 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.

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

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.

Treating contractors like employees: Requiring specific hours, providing equipment, conducting performance reviews, 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, consider converting them to employment or ensure they maintain other clients.

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

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

The bottom line

Contractor compliance isn't about perfection—it's about reducing risk. Structure relationships to emphasize independence, maintain proper documentation, include IP and confidentiality clauses, and communicate appropriately. These basics cover most situations.

For complex situations—long-term relationships, high-value engagements, international contractors in strict jurisdictions—consult qualified counsel. The cost of advice is far less than the cost of misclassification.