If you’re looking to hire an independent contractor to do some work for your business, you need to learn how to also pay an independent contractor.
An independent contractor is a self-employed business owner who works on a contract basis with other companies or the general public. The general rule for determining if your worker is an independent contractor is if you have control only over the result of the work, not how they get the work done.
There are, however, varying rules on the state level that dictate who can be classified as a contractor. Take a look at our article on independent contractor laws to learn more.
Contractor pay in the United States is different from running payroll for your regular staff in terms of labor laws and tax requirements, so take some time to learn the rules to ensure you prepare yourself to practice the best way to pay independent contractors.
Before you hire a contractor
Gather the following information before beginning your contractor hiring process:
- Your Employer ID Number (EIN): The IRS requires you to register your business before you start hiring. You’ll receive a 9-digit tax ID number that you’ll use for IRS reports. You can apply online on the IRS Employer ID Numbers site.
- Form W-9: This is the Request for Taxpayer Identification Number and Certification, and it’s used to identify the contractor and provide the information needed to pay them and submit them to the IRS. You should request this from your contractor.
Decide contractor payment terms
You and your contractor can negotiate and agree upon the terms of your payment structure by choosing from a couple of different options.
Some contractors prefer that you pay them on an hourly basis, meaning they receive compensation based on how much time they spend on the job. The alternative compensation plan is to pay by the job. If a contractor agrees to this strategy, you would pay a set amount when they complete the work.
You will also need to agree on the payment amount. Most contractors come with their own number. But if you want to get a better feel for the going rate, you can call around for quotes from other businesses.
Whatever payment system you and the contractor decide during negotiations needs to be detailed in a written contract. You should also include a few more important details:
- A timeline of the project as well as deadlines for different areas of completion
- Ownership rights, including intellectual property rights in terms of graphics or any other work they create
- A confidentiality agreement, if needed
- What happens if the work isn’t acceptable or completed on time
- What happens if you don’t deliver the payments on time
It’s a good idea to have an employment lawyer write up this agreement for you,or at least take a look at it before finalizing the details.
A 1099-NEC Form is essentially an independent contractor pay stub or proof of income. Before 2020, the IRS used the 1099-MISC Form for this purpose, but they now only use it for miscellaneous income.
The form is used to report independent contractor income at the end of the year. You will give a copy of the form to the contractor, who will then use it to determine how much they owe in taxes.
If you paid the contractor more than $600 throughout the year, you also need to submit a copy to the IRS. Your year-end reports are due on January 31 of the following year.
You are not responsible for withholding payroll taxes, including Social Security and Medicare, on behalf of the contractor. However, if the IRS finds that the taxpayer ID the contractor submitted on the W-9 is incorrect, they may tell you to withhold taxes from that contractor’s income.
If this occurs, the backup withholding rate is 24%. You would calculate the withholding amount by multiplying the gross wages by .24. You’ll use Form 945 to submit backup withholding taxes, which are due for the previous year on January 31.
It’s very important to follow every instruction the IRS provides in the backup withholding notice exactly as directed.
If you don’t have a system in place for paying workers, you’ll have to decide what method you want to pay them with. It’s not recommended to pay the contractor using cash because you should save your payment history in your records.
You can opt to have the payment directly deposited into their bank account, but be aware that your bank will most likely charge you an additional fee for doing so. Many companies also use a service like this if they don’t have employees, meaning they don’t have a payroll service.
The best way to pay contractors is to go through a full-service payroll platform like Homebase. When you run payroll, Homebase calculates taxes and paychecks, sends direct deposits to your team, and automatically pays and files your payroll taxes.