This article is part of a larger series on How to Do Payroll.
Paying independent contractors is simpler and often cheaper than paying employees because employers don’t have to withhold or pay taxes. Although year-end reports are required to show amounts paid, labor laws that cover employees—like minimum wage—don’t apply. We walk through the five steps for paying independent contractors below.
If you’re looking for an easy way to pay independent contractors, consider Gusto. You can pay contractors through direct deposit, and all payments will be reported at the end of the year on IRS Form 1099. In addition, you’re only charged during the months you actually pay your contractors, and even then, it’s only $6 per person monthly. Sign up for a 30-day free trial today.
Step 1: Determine How to Pay Contractors
Paying independent contractors isn’t difficult, but it is different from paying employees. Determining how to pay independent contractors (using payroll software in-house vs outsourcing to a payroll service) and how much to pay are some of the first decisions you’ll make to ensure the process goes smoothly.
Unlike with employees, you don’t typically pay contractors a salary. Instead, you should consider whether an hourly or per-project price would be more appropriate, their pay rates, and any payroll taxes to consider.
Once you and your contractor agree on payment terms—including project due dates, required deposit, rates, and so forth—you’re ready to complete an official independent contractor agreement. This solidifies the deal and binds you both to deliver accordingly.
Step 2: Collect W-9 Forms
Once you decide how much and often to pay your contractors, you’ll have them complete a W-9 Form, which includes personal information, like name and Social Security number. It’s important to have all contractors complete this form before beginning work because you’ll use it to report their annual earnings on Form 1099 at year-end.
Pro Tip: Require each independent contractor you work with to complete the W-9 Form before beginning any work.
There have been rare cases when independent contractors refused to provide their Social Security number or entered an incorrect Social Security number on their W-9; when that happens, the IRS will notify you to immediately begin withholding 24% of the contractor’s pay for backup withholding (taxes). In this case, you’d withhold, regardless of the contractor’s dismay, and remit to the tax agency as instructed.
If you opt to use payroll software or a service like Gusto, collecting the W-9 is simple. Once you add contractors to your account, it will email them a link they can use to start their online accounts. It’ll also prompt them to provide all of the W-9 information before storing it within the application, saving you time and money. Sign up for its free 30-day trial.
Step 3: Set Up Contractors in Your Payroll System
Once you’ve collected the W-9 Form, you’re ready to set up contractors in your payroll system, which may consist of a notebook, Microsoft Excel, or payroll software. However you choose to do payroll, you need to start by ensuring you’ve recorded all of your contractors’ information; this will help prevent any hiccups on payday.
Step 4: Process Payments to Independent Contractors
After setup, you won’t have much to do until it’s time to make the first payment. If the agreement requires a deposit before beginning work, you’ll need to process it immediately after setup.
Select the Payment Method
There are many different ways to pay your team for their work. You can pay using cash (not recommended due to lack of paper trail), check, direct deposit, and even pay cards, which are reloadable prepaid debit cards employers use to deposit wages. Be mindful of processing times; direct deposit, for example, requires up to four days to process.
Direct deposits usually cost additional money if you’re not using a payroll service and go through your bank instead; however, if you only need to process a few payments, you can print checks online for free. Most of the best payroll software offers direct deposit at no additional charge, and some will guide you through printing your own checks using the system.
Pay cards are typically offered by the larger payroll providers, like Paychex, so while the pay card program is free, the payroll services you’re required to purchase before being approved for the program are usually more expensive.
Step 5: Send 1099-NEC Forms
As the end of the year approaches, you should be ready to prepare 1099-NEC Forms for each contractor to whom you’ve paid more than $600 within the year. You’ll have to distribute a copy of the 1099 to each contractor along with the IRS and state tax agency (if there are state income taxes), and it must include the total amount you paid during the year.
Don’t forget to keep a copy for your records, and be mindful of the Jan. 31 deadline to report any payments made during the previous calendar year. You’ll use the W-9 forms you collected from contractors before them beginning work; transfer information (such as name, address, and Social Security number) to the 1099-NEC to ensure the year-end reports you submit to the IRS are accurate.
The 1099-NEC Form helps independent contractors calculate how much they owe in taxes. It also helps the IRS track contractors from whom they should receive tax payments.
It’s important to note that this process will look very different if you’re processing payments for international contractors. You’ll often be dealing with international banks and exchange rates and handling different forms. International contracting companies are required to submit a W-8BEN-E to your business—or a W-8BEN if the contractor is operating as an individual—before getting paid.
Processing payments for international contractors can be confusing, but there are many payroll services that can help take the burden off you. If you’re interested in a payroll service that can help you, check out our guide to the best international payroll services.
Laws for Paying Independent Contractors
Learning how to pay independent contractors involves understanding the legalities surrounding it. One major error some companies make is confusing employees with independent contractors. Federal law is pretty strict in differentiating between the two; thus, misclassifying can result in thousands of dollars in fines and taxes owed.
Keep in mind that contractors control how they deliver the finished project and how often they work. The only factor you determine is how the final product should look.
There are numerous factors to consider when classifying independent contractors. The DOL has an opinion, as does the IRS and many states. Although there are no hard and fast rules, If you’re ever confused, complete and submit Form SS-8 to the IRS; the IRS will review and make an official classification determination, but it could take up to six months.
We’ve researched payroll providers that will help you pay contractors easily. If you’re interested in payroll software but need help deciding which is best for your business, check out our guide to choosing contractor payroll services.
Determining how to pay independent contractors isn’t too complex if you set up an effective system to help you track contractor and payment information. You can use a notebook, Excel, or payroll software to help, and costs range from $0 to $6 a month for one contractor.
If you’re looking for payroll software that supports contractor payments, consider Gusto. It collects all of the information needed to prepare 1099-NEC forms at year-end. It also makes it easy for contractors to review their payments and tax documents by prompting them to set up an online account. In addition to giving contractors control of their paperwork, you save money and time by not having to print and distribute tax documents. Sign up for its 30-day free trial today.