So you want to hire an independent contractor? When it comes to payroll, that worker classification refers to the temporary help you hire for your business. For your cash flow, bringing on a contingency workforce rather than part-time or full-time employees may be the best approach. But as a small business owner, it’s important to know how to pay 1099 workers and how to report those contractor payments to the Internal Revenue Service (IRS).
Not sure if you are hiring a contractor or an employee? Check the IRS regulations. (This is important, because if there is a misclassification of someone as a contractor when they should’ve been classified as a W-2 employee, then the company or the worker can submit Form SS-8 for a determination. If you made an error, you could owe unpaid wages and taxes. This issue has come up a lot in the news because of the gig economy.) Once you are sure you are bringing on a contractor (including freelancers), follow the steps below.
1. Have your contractor fill out a Form W-9
This will provide you with all their identifying info. Make sure to keep the IRS Form W-9 in your bookkeeping records for at least four years, and pay close attention to the business classification (i.e., sole proprietorship, S corp, etc.), which will appear in box 3 at the top of the form. This will help you determine whether or not you need to file a 1099-NEC form in January.
Also, be sure to check whether the independent contractor is subject to backup withholding or not (line 2 under Part II). If the contractor does not supply you with a valid taxpayer identification number (TIN) in Part I, then you will be required to deduct backup withholding from their nonemployee compensation for the tax year. (The TIN can be a Social Security Number or an Employer Identification Number.) Failure to pay backup withholding can leave you responsible for any uncollected tax liability, so it’s important to get it right. The Internal Revenue Service (IRS) will collect self-employment taxes (i.e., Social Security taxes and Medicare taxes) one way or another!
2. Get them the money
When you’re paying independent contractors, you’re generally not withholding taxes before you give them the money, and they’re not receiving employee benefits such as health insurance. They take care of their own taxes before and during tax return time. However, based on the number of hours you’re using the contractors (especially if they have a retainer with you for an ongoing period of time) and other factors related to following labor laws, you may choose to use a staffing agency that is hiring and paying contractors on W-2s and handling payroll taxes.
Some employers choose to write their contractors checks, while others get permission to pay contractors via direct deposit to their bank account (note: authorization forms are required!), and some use websites like PayPal to electronically transfer the funds. Many payroll services can also process these payments as a convenience, as long as you are already using them to pay your employees.
3. Pay any backup withholding that you withheld to the IRS
If there were backup withholdings with your contractor, get that money to the IRS. And make sure to get any state taxes that were withheld to the appropriate state taxing authority, too.
4. Fill out a 1099-NEC
If you pay an independent contractor more than $600 in the year and their business entity is not an S corp or a C corp, then you must file Form 1099-NEC. (Form 1099-MISC is no longer used for this.) Regarding payment methods, the exception to this rule is if you paid via credit card or a third-party payment platform, like PayPal. In that case, the payment settlement entity may be required to issue a 1099-K tax form if certain thresholds are met. If you withheld any federal income tax, you’ll report the backup withholding amount in Box 4 of the 1099-NEC.
Business owners need to send Copy A of 1099-NEC forms to the IRS and Copy B to contractors by January 31—or the following Monday if January 31 falls on a weekend.
If you’ll be sending your 1099-NEC to the IRS via post, be sure to include the required cover sheet, Form 1096: Annual Summary and Transmittal of US Returns. To file electronically, you’ll need a Transmitter Control Code (TCC), and follow the latest IRS instructions and deadlines for how to do this.
You may also need to send the 1099-NEC to your state, the state where your contractor works, and/or resides. Be sure to check with your CPA to ensure your small business is compliant with state and local laws.
Independent contractor FAQs
How do I handle backup withholding if a contractor fails to provide a W-9 form?
If your contractor doesn’t provide you with a W-9 form—and you’ve requested one at least three times—you’ll need to start backup withholding. That means you’ll hold back part of the contractor’s payment to give to the IRS. The IRS’s flat rate for backup withholding is 24%. In the meantime, make sure you reach out to let the contractor know that unless they send over their taxpayer identification number, you’re responsible for submitting 24% of their future payments to the IRS. If the contractor still doesn’t comply, you’ll have to report the backup withholding information when you file Form 945.
How should I structure my contract or agreement with an independent contractor regarding payment terms?
There are a variety of ways to structure payment terms with an independent contractor. Usually, it’s good practice to ask what your contractor’s preferred terms are; some contractors charge a deposit for services upfront, or invoice at certain project milestones. Others are fine with a single invoice upon completion of a project or receipt of deliverables, and a Net 30 payment. Once you know what your contractor prefers, you can either honor their preference or find a way to meet in the middle that works for your accounts payable. In your written contract, make sure you specify how much a contractor’s services cost, when and how they should invoice, and when and how they can expect to receive payment.
Do I need to carry Workers’ Compensation insurance for independent contractors?
No, you don’t need to carry workers’ compensation insurance for independent contractors, since they’re not your employees. That said, it’s smart to check with your state and industry laws to make sure your contractor isn’t an exception for some reason.
Are there specific state-level rules for paying contractors that differ from federal rules?
Yes, some states have specific rules for paying contractors that might be different from the federal rules. Some states have their own worker classification tests/requirements (like the ABC test) to prevent misclassifying a contractor, while others have prevailing wage laws or laws around how often contractors need to be paid. Make sure you check your state’s department of labor website for the most accurate information.
How to use Gusto to pay independent contractors FAQs
Can I use Gusto to pay independent contractors?
Yes, in addition to your full- and part-time employees, you can also pay contractors through Gusto. We also automatically file your required new hire reporting for you, and generate, file, and deliver 1099-MISC forms at the end of the year at no extra cost. Gusto allows you to track and report all of your contractor payments in one place, so you can spend more time focusing on running your business. Learn more about paying contractors.
What about international contractors?
Yes! You can use Gusto to pay international contractors (and remote employees in different countries). Hiring international contractors is a great way to access talent outside your local area. Gusto makes it super easy to deliver international payments on time—and in your contractor’s home currency.
What do I need to pay a 1099 contractor with Gusto?
You can get started with Gusto to easily pay contractors. If you’re setting up payroll for the first time, we suggest reading our list of everything you need to know. If you already have payroll through a different service, check out our guide to switching.
