Can You Give Bonuses to Independent Contractors?

Many small business owners are self-employed or have very few employees, and these businesses often have a number of functions that must be addressed but not enough employees to address them. These businesses augment employee staff by hiring independent contractors. Business owners must exercise caution when hiring independent contractors and be careful not to treat them as employees.

Small business owners sometimes prefer independent contractors because the accounting and administrative paperwork is simpler than for employees. However, companies must ensure they maintain compliance with the IRS' definition of who is an independent contractor. You can give bonuses to independent contractors as long as you address the specific reasons and metrics for the bonus in a formal, written agreement with the contractor.

The IRS has a number of criteria that determines who is an independent contractor. The criteria falls into three categories: behavioral, financial and type of relationship. An independent contractor controls how and when he does his job. A contractor specifies the how and when of payment, the reimbursement of expenses and the provision of equipment and tools. Contractors also have contracts, approved proposals or similar written documents.

For example, if you hired a bookkeeper as an independent contractor, you would sign an independent contractor agreement, contract or proposal with him or his company. You would specify the end result you expect, the frequency of engagement and the hourly or project rate. If you wanted to provide an incentive or bonus, in the contract you would specify a performance bonus as a dollar amount, percentage of savings or percentage of net income. If either of you neglected to address the bonus in the agreement, you could add it by way of an addendum later.

Employees require the withholding of Medicare and Social Security taxes, payment of unemployment taxes and overtime. By documenting your overall work and bonus arrangement with your independent contractor in writing -- and ensuring that you do not have employees in similar roles that you treat the same -- you comply. If the IRS determines that you have intentionally misclassified employees as independent contractors, then you may be subject to back payment of the employment-related taxes.