Contracting With Outside Consultants

By: Eileen Morgan Johnson

When working with consultants, avoid potential pitfalls (and tax implications) with the right contract.

Q: How can my association ensure success when entering a relationship with an independent contractor?

A: There are a several steps the association and the consultant can take toward a successful relationship, but the most important is to define their expectations in a written agreement.

Whatever you call it—contract, agreement, proposal, LOA, MOU, MOA, or term sheet—a written agreement helps both sides know what to anticipate from the relationship and provides direction as the project unfolds. While is it usually advisable for an attorney to review the contract, the parties can help define their relationship by drafting the initial terms.

Go back to high school English class for guidance. A good contract will include the basics of a good essay—who, what, when, where, why, and how. Add on "how much" and you have the basics of a contract.

  • Who: Name the parties and any specific individuals who are important to the project.
  • What: Describe the service or activity that will be provided by the consultant.
  • When: Establish due dates for project milestones when the consultant is expected to check back with the association or provide finished or draft products.
  • Where: State whether the consultant is expected to work from his or her own office, at the association's office, at a hotel hosting a board meeting, or some other location.
  • Why: Give the reason for the project and its objective(s) in clear terms.
  • How: Specify the process to be used in providing the service.
  • How much: Define the payment terms and any cost reimbursements.

There is one additional question you must ask when working with a consultant: Is this person truly an independent contractor? This is the question the IRS and your state labor department will be asking.

A few years ago, the IRS simplified its 20-factor test for independent contractors and developed a new test that focuses on three main factors:

  1. Behavior control. Instructions and training provided by the client;
  2. Financial control. How the consultant is paid, unreimbursed expenses, the consultant's investment in the consulting business, the consultant's ability to generate a profit or loss, the consultant's services that are made available to the public;
  3. The relationship of the parties. Whether employee benefits are provided, existence of a written contract, a long-term relationship, and the extent to which the services provided are a key part of the client's business.

Sometimes applying these factors will lead to a clear determination that the consultant is an employee or an independent contractor. More often than not, however, the consultant will not fall neatly into one classification. If the employer had a reasonable basis to consider the worker an independent contractor (such as the opinion of an attorney), the employer can escape the penalty for failure to file an information return.

People who do not qualify as independent contractors will likely be considered your association's employees, and your association is liable for paying employment taxes and withholding taxes from its employees. Employers who misclassify employees as independent contractors can be surprised by big tax bills with interest and penalties, and new employees who demand the same benefits as other employees.

An employer who misclassifies an employee as an independent contractor is liable under Internal Revenue Code §3509 for a withholding tax of 1.5 percent of wages paid and an employee Social Security tax of 20 percent of wages paid. The taxes double if the employer did not file an information return.

Consultants are valuable members of the association community and provide much-needed assistance to associations. Just be sure when you work with a consultant that you are hiring a true independent contractor and not an employee.

Eileen Morgan Johnson is counsel with Whiteford, Taylor & Preston, LLP, and a member of ASAE & The Center's Consultant Section Council. Email: [email protected]

Eileen Morgan Johnson

Eileen Morgan Johnson is a partner at Whiteford, Taylor & Preston, LLP, in Washington, DC.