How to Legally Hire Freelancers in the U.S.

Hiring freelancers and independent contractors offers businesses flexibility, specialized expertise, and cost savings—but only if done correctly. Misclassifying employees as contractors can result in massive penalties, back taxes, and legal liability that can bankrupt small businesses. With the IRS and Department of Labor cracking down on misclassification, understanding the legal requirements for hiring freelancers has never been more critical for protecting your business.

What Makes Someone a Freelancer or Independent Contractor?

The distinction between employees and independent contractors isn't just about what you call them—it's a legal classification with serious tax and liability implications. Courts and government agencies use multiple tests to determine worker classification, focusing on the degree of control and independence in the working relationship.

The Three Tests for Independent Contractor Classification

1. IRS Control Test (Revenue Ruling 87-41)

The IRS uses three categories to determine worker classification:

Behavioral Control

• Instructions given: How detailed are your directions about how work is performed?
• Training provided: Do you train the worker on your procedures?
• Work evaluation: Do you evaluate how the work is done or just the end result?
• Work sequence: Do you dictate the order in which work is performed?

Financial Control

• Significant investment: Does worker have substantial investment in equipment/facilities?
• Unreimbursed expenses: Does worker pay their own business expenses?
• Opportunity for profit/loss: Can worker realize a profit or incur a loss?
• Services to multiple clients: Is worker free to work for others?
• Payment method: Paid by project/job rather than hourly/weekly?

Type of Relationship

• Written contracts: What does the agreement specify about the relationship?
• Employee benefits: Does worker receive benefits like insurance or paid leave?
• Permanency: Is relationship ongoing or for specific project?
• Key services: Is work performed a key aspect of regular business?

2. Department of Labor Economic Reality Test

The DOL focuses on economic dependence with six factors:

Six Factor Analysis

• Integral to business: Is work integral to employer's business?
• Managerial skill: Does worker's managerial skill affect profit/loss opportunity?
• Investment comparison: How does worker's investment compare to employer's?
• Special skills required: Does work require special skill and initiative?
• Permanence of relationship: Is relationship permanent or indefinite?
• Nature and degree of control: Who controls meaningful aspects of work?

3. State ABC Tests (California and Others)

Many states use the stricter ABC test, requiring all three conditions:

ABC Requirements

• A - Autonomy: Worker free from control and direction in performing work
• B - Business of employer: Work outside usual course of hiring entity's business
• C - Customarily engaged: Worker customarily engaged in independent trade/occupation

Essential Legal Documents for Hiring Freelancers

1. Independent Contractor Agreement

The foundation document: Establishes the legal relationship and protects both parties.

Key Provisions to Include:

• Scope of work: Detailed description of services and deliverables
• Payment terms: Amount, schedule, and method of payment
• Timeline: Start date, milestones, and completion deadline
• Independent contractor status: Clear statement of non-employee relationship
• Intellectual property rights: Who owns work product and when
• Confidentiality: Protection of sensitive business information
• Indemnification: Protection from liability for contractor's actions
• Termination: How either party can end the relationship

Avoid These Red Flags:

• Set hours: Don't specify when work must be performed
• Exclusive service: Don't prohibit work for other clients
• Training requirements: Don't require attendance at company training
• Company equipment: Don't require use of your tools/equipment
• Detailed supervision: Focus on results, not methods

2. Form W-9: Request for Taxpayer Identification Number

Required before first payment: Collects contractor's tax information.

W-9 Requirements:

• Legal name: Individual or business entity name
• Business name: If different from individual name
• Federal tax classification: Individual, LLC, corporation, etc.
• Address: Where 1099 will be sent
• Taxpayer ID: SSN for individuals, EIN for businesses
• Certification: Contractor certifies information under penalty of perjury

W-9 Best Practices:

• Collect before payment: Never pay without completed W-9
• Verify information: Check that name matches tax ID
• Update annually: Request new W-9 each year
• Secure storage: Protect sensitive tax information

3. Statement of Work (SOW) or Project Agreement

Project-specific details: Supplements master contractor agreement.

SOW Components:

• Project description: Detailed explanation of work required
• Deliverables: Specific items to be provided
• Acceptance criteria: How work will be evaluated
• Timeline: Milestones and deadlines
• Payment schedule: Tied to deliverables or milestones
• Change procedures: How to handle scope changes

4. Non-Disclosure Agreement (NDA)

Protect confidential information: Essential when sharing sensitive data.

NDA Considerations:

• Mutual vs. one-way: Determine if contractor shares confidential info
• Definition scope: Clearly define what's confidential
• Duration: How long confidentiality obligations last
• Permitted use: Limited to performing contracted services

5. Intellectual Property Assignment

Critical for creative work: Ensures you own what you pay for.

IP Assignment Options:

• Work for hire: Limited to specific categories under copyright law
• Assignment upon payment: Rights transfer when invoice paid
• License agreement: Contractor retains ownership, grants usage rights
• Joint ownership: Shared rights for collaborative works

Tax Obligations When Hiring Freelancers

Form 1099-NEC Requirements

Annual reporting obligation: Report payments to independent contractors.

1099-NEC Filing Rules:

• $600 threshold: Must file if paid $600+ in tax year
• Services only: For services, not merchandise
• Business payments: Payments made in course of business
• Deadline: January 31 to contractor and IRS
• Electronic filing: Required if filing 250+ forms

Exceptions to 1099 Filing:

• Corporations: Generally exempt except attorneys
• Payment method: Credit card payments reported by processor
• Personal payments: Not made in business context
• Foreign contractors: Different rules apply

Backup Withholding

Required in certain situations: 24% withholding from payments.

When Backup Withholding Applies:

• No TIN provided: Contractor hasn't provided taxpayer ID
• IRS notification: Incorrect TIN reported previously
• Certification failure: Contractor doesn't certify TIN correct
• IRS instruction: Notice to begin backup withholding

State Tax Considerations

• State income tax: Some states require withholding for contractors
• Unemployment insurance: Contractors may be covered in some states
• Workers' compensation: May need coverage for contractors
• Local taxes: City or county tax obligations

Best Practices for Working with Freelancers

Before Hiring: Due Diligence

Verification Steps:

• Business entity check: Verify LLC or corporation status
• Insurance verification: Confirm professional liability coverage
• Portfolio review: Evaluate past work quality
• Reference checks: Contact previous clients
• License verification: Check required professional licenses

Red Flag Contractors:

• Former employees: High risk of misclassification claims
• Single client: Works only for your business
• No business presence: No website, cards, or marketing
• Employee-like demands: Wants benefits or set schedule

During the Relationship: Maintaining Independence

Do's:

• Focus on results: Specify what, not how
• Allow flexibility: Let contractor set own schedule
• Project-based pay: Pay by deliverable, not time
• Respect autonomy: Treat as separate business
• Written communications: Document project discussions

Don'ts:

• Mandatory meetings: Don't require attendance at staff meetings
• Company email: Don't provide company email addresses
• Performance reviews: Don't conduct employee-style evaluations
• Training programs: Don't require company training attendance
• Exclusive service: Don't prohibit other clients

Payment Best Practices

Payment Structure:

• Milestone payments: Tie payments to completed deliverables
• Net terms: Standard 30-day payment terms
• Clear invoicing: Require detailed invoices
• No reimbursements: Contractor covers own expenses
• Electronic payments: Maintain payment records

Avoiding Payment Issues:

• Clear payment terms: Specify in contract
• Approval process: Define how work is accepted
• Dispute resolution: Include mediation clause
• Kill fee provision: Payment if project cancelled
• Late payment penalties: Interest on overdue amounts

Industry-Specific Considerations

Technology and Software Development

• Source code ownership: Clear IP assignment crucial
• Open source usage: Disclosure requirements
• Security requirements: Data protection obligations
• Non-compete issues: May be unenforceable for contractors

Creative Services

• Work for hire limitations: Only certain categories qualify
• Moral rights: May not be waivable in some jurisdictions
• Portfolio rights: Contractor's right to showcase work
• Revision limits: Specify number included in price

Construction and Trades

• Licensing requirements: Verify contractor licenses
• Insurance mandates: General liability and workers' comp
• Permit obligations: Who obtains required permits
• Lien waivers: Protect against mechanics' liens

Professional Services

• Professional liability: Errors and omissions coverage
• Regulatory compliance: Industry-specific rules
• Client confidentiality: Special obligations for sensitive data
• Credential verification: Professional licenses and certifications

Common Mistakes and How to Avoid Them

Misclassification Mistakes

High-Risk Situations:

• Converting employees: Laying off employees and rehiring as contractors
• Long-term relationships: Same contractor for years
• Full-time hours: Contractor works 40+ hours/week
• Integrated roles: Contractor performs core business functions
• Supervised work: Direct oversight of how work performed

Protective Measures:

• Multiple clients: Encourage contractor to work for others
• Business presence: Contractor has own business entity
• Own tools: Contractor provides equipment
• Marketing efforts: Contractor advertises services
• Risk of loss: Contractor can lose money on projects

Documentation Failures

Common Oversights:

• Verbal agreements: No written contract
• Outdated contracts: Using old templates
• Missing W-9s: No tax documentation
• No IP assignment: Ownership unclear
• Insufficient records: Can't prove contractor status

Documentation Best Practices:

• Written everything: All agreements in writing
• Annual updates: Review contracts yearly
• Organized files: Separate folder for each contractor
• Electronic copies: Scan and backup all documents
• Retention policy: Keep records 7+ years

When Things Go Wrong: Dispute Resolution

Common Freelancer Disputes

• Scope creep: Work exceeds original agreement
• Quality issues: Deliverables don't meet expectations
• Payment disputes: Disagreement over amounts owed
• Deadline misses: Projects delivered late
• IP ownership: Disputes over who owns work product

Resolution Strategies

Preventive Measures:

• Clear contracts: Detailed scope and expectations
• Regular check-ins: Milestone reviews
• Change orders: Written approval for scope changes
• Payment schedules: Tied to completed milestones
• Dispute clause: Mediation before litigation

When Disputes Arise:

• Document issues: Written record of problems
• Attempt resolution: Direct communication first
• Mediation: Neutral third party assistance
• Legal action: Last resort for significant issues
• Collection procedures: For non-payment situations

Future Trends in Freelance Hiring

Legislative Changes

• Federal legislation: Proposed national standards for classification
• State law expansion: More states adopting ABC test
• Gig economy rules: Platform-specific regulations
• Portable benefits: New models for contractor benefits

Technology Impact

• Automated compliance: Software for classification decisions
• Blockchain contracts: Smart contracts for payments
• AI matching: Better contractor-project matching
• Remote work tools: Enhanced collaboration platforms

Protect Your Business While Leveraging Freelance Talent

Hiring freelancers can transform your business with specialized skills and flexibility, but only when done legally. Proper classification, comprehensive contracts, and compliant tax handling protect your business from costly penalties while building successful contractor relationships. The key is treating freelancers as the independent businesses they are, not as employees without benefits.