How to Pay Independent Contractors: A Guide

Hiring independent contractors gives businesses the flexibility to bring in help when they’re understaffed or lack the expertise to complete a project.

However, paying independent contractors isn’t the same as employees. Contractors have the freedom to negotiate their pay scale and schedule as well as choose their preferred payment method. As self-employed entities, there are also different tax and payroll regulations for contractors.

In this article, we will walk you through how to pay your independent contractors so that your business, the contractor, and the tax collector are happy at the end of the day (or fiscal year, in this case).

Key Takeaways

  • Independent contractors are responsible for paying their own taxes, while employers manage taxes for full-time employees.
  • Establish contract terms (rate, pay schedule, project scope, etc.) before you begin the project to ensure everything runs smoothly.
  • Request W-9 forms from contractors before the contract begins so you can validate the information and avoid issues while filing taxes.
  • Provide contractors with 1099-NEC before January 31st so they can file their taxes on time.

How to Pay Independent Contractors – Step By Step

Paying contractors is relatively easier than paying your employees. But it still comes with nuances. To make it easier, we broke down how to pay your contractors into five simple steps:

  • Step 1: Differentiate between your independent contractors and employees
  • Step 2: Set payment rates and pay frequency
  • Step 3: Ask for a completed W-9 form
  • Step 4: Pay your contractors
  • Step 5: Organize 1099 tax documents

Now that you have the gist, let’s look at each step in more detail.

Step 1: Differentiate between your independent contractors and employees

It’s important to identify the independent contractors and full-time employees in your payroll because, as employers, it’s your responsibility to withhold taxes and other deductions for full-time employees.

Whereas, independent contractors are self-employed in the eyes of the Internal Revenue Service (IRS), making it the contractor’s responsibility to pay self-employment tax themselves.

You can differentiate between independent contractors and full-time employees using these IRS guidelines:

  1. Does the employer control how the worker completes the project?
  2. Who controls the financial aspects of the job (expenses, supplies, subscriptions, etc.)?
  3. How does the contract define the relationship between the employee and the company?

Simply put: If you only have control over the results of the job and not how it is done, then the person you employed is an independent contractor.

NOTE: These aren’t rules but just guidelines. Depending on the state and local laws, someone who is an employee in one state is actually an independent contractor in another.

Businesses that misclassify employees, even by mistake, can face serious repercussions. If you’re not sure about anyone in your payroll, file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes, and Income Tax Withholding with the IRS.

Step 2: Set payment rates and pay frequency

Contractors are also compensated differently from full-time employees. It’s what entices people to choose contracting in the first place.

For contractors, compensation is made up of two factors:

  • Project rate is the pricing model used by the contractor. It could be hourly, monthly, per project, or per milestone. Contractors usually set their rate so consider whether it fits your budget before committing.
  • Pay frequency is how often the contractor wants to be paid. Contractors commonly prefer a Net30 payout, where payments are made every 30 days. But they may also request payments every week, every 15 days, and so on. Some contractors may require full payment upfront.

The compensation structure can vary based on the contractor and project. It is important to set expectations from the start and put it down in writing. The contract should outline the scope of the project, rate and pay schedule, any bonuses and incentives, and reasons for termination.

Step 3: Ask for a completed W-9 form

The W-9 form is used to request the contractor’s Taxpayer Identification Number (TIN). It is required on all tax returns filed with the IRS for both contractors and employers.

Collect the W-9 at the start of the contract so you have ample time to validate its information before you submit your 1099 at the end of the year. You can ask your contractor to send it electronically or via mail, but we recommend investing in a payroll system since it’s more secure.

Step 4: Pay your contractors

Ensuring your contractors are paid on time is probably the most important step in this whole process. You have multiple options to ensure this happens, of which we’ll cover the three most popular ways to pay independent contractors:

  • Traditional checks: Sending checks for services rendered is the most tried and tested method in this list. You can send it via mail or hire a payroll service to create and send the checks. However, traditional checks are less secure because anyone can open them, or they can get damaged during transit.
  • Direct bank transfers: Using automated clearing house (ACH) networks or wire transfers to send money directly to their bank account is the most common way to pay contractors. ACH transfers are typically free. You just need the contractor’s account details and to specify whether it’s a one-time or recurring payment. Wire transfers are fast as well, but there’s usually a transaction fee.
  • Digital payment platforms: Online payment platforms like Google Wallet, PayPal, and Apple Pay are great options for paying your contractors. They’re secure and instantaneous, and you can easily track your payments on the platform. If you’re working with multiple contractors, consider investing in payroll software. It streamlines your workflow while ensuring every transaction is completed securely.

However, every region has its own laws governing contracts and payroll, so thoroughly research the best payroll software on the market before making a decision.

Step 5: Organize 1099 tax documents

As we mentioned earlier, it’s the responsibility of contractors to file their own taxes—this means filling out Form 1040-ES, Estimated Tax for Individuals, which includes Form 1099 from their client.

The Form 1099 is a collection of tax forms documenting any income received by contractors or freelancers. There are three versions of Form 1099:

  • Form 1099-NEC: This reports how much a business pays annually to non-employees, including independent contractors.
  • Form 1099-MISC: This reports a business miscellaneous expenses like rent, utilities, etc.
  • Form 1099-K: This reports a business’ card transactions through third-party networks.

Contractors only need Form 1099-NEC from you, outlining how much you’ve paid them. Ensure they receive it before January 31st, as that’s the deadline for submitting the form.

Legally, you only need to send the form if you’ve paid them over $600. But it’s good practice to include the 1099 irrespective. Also, submit copies of the form to federal and state tax agencies, and keep a copy with yourself.

There may be cases where you’ll need to withhold taxes for the contractor. This is called backup withholding tax and typically occurs when the contractor submits the wrong TIN or incorrectly files income tax returns.

Managing all the tax documents can become cumbersome if you don’t have the right systems in place. To make the job easier, consider using payroll software.

Utilizing Payroll Software and Platforms

Payroll software helps businesses manage the entire payroll lifecycle. From collecting employee information during onboarding to paying out the final paycheck, it streamlines payroll processes for both your full-time employees and independent contractors.

Benefits of Using Payroll Platforms for Paying Independent Contractors

Payroll software can simplify how you pay your independent contractors in the following ways:

  • It usually supports direct deposits and wire transfers, ensuring payments reach your contractor’s bank accounts on time.
  • It allows businesses to store and manage all their payroll records and information in one place.
  • It automatically generates Forms 1099-NEC and 1099-MISC which contractors can access it directly.
  • It provides in-depth reports to understand how much your business has paid independent contractors in a fiscal year.

Conclusion

Paying independent contractors may leave you scratching your head at first. But with a streamlined process, it can become easier than paying your full-time employees.

Start by understanding who in your payroll are independent contractors and set expectations with these individuals from the get-go. Also, don’t forget to collect the necessary information from them to make payouts and tax filing easier once the job is done. Just ensure you are complying with the federal and state tax regulations, as it’s different for both contractors and full-time employees.

If you’d like to learn more about payroll tax regulations, check out our in-depth guide on how to calculate your payroll taxes.

FAQ

Who is responsible for filing an independent contractor’s taxes?

How to identify if someone is an independent contractor?

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Kevin Cyriac Tom
Tech Expert

Kevin is a seasoned B2B SaaS writer with a passion for crafting engaging BoFU articles, including in-depth product reviews and solution-oriented pieces. His fascination with writing began after he won a second grade creative writing competition, sparking a lifelong love for the power of words. Kevin initially pursued a degree in Mechanical Engineering at the prestigious VIT University in India. But his trajectory took an unexpected turn after a digital marketing internship reignited his love for writing, prompting Kevin to pivot towards content creation instead. Kevin joined multiple B2B SaaS startups as their primary content writer, honing his writing and…