1099 Payroll: How to Pay Contractors in 6 Legal, Hassle-Free Steps
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Independent contractors (also referred to as 1099 employees) are self-employed individuals who work with companies as clients, usually on specific projects for a limited time. Unlike full-time employees, who typically work for a single employer, contractors often work with several clients and manage their own taxes, bookkeeping, schedules, and tools for work.
Independent contractors, sometimes called freelancers, offer many benefits to employers, especially ones that have fluctuating workloads or want to trial a potential employee before committing to full-time employment. Contractors are also more affordable than full-time employees: they provide their own tools and equipment and don’t receive employer benefits or payroll tax contributions.
However, companies don’t pay contractors through regular employee payroll so they must follow specific steps to ensure they are paying contractors legally and compliantly. In this post, we’ll walk you through the six steps to pay your local and international contractors as a US-based company.
1. Collect necessary documents before you start working with contractors
The first step, before you hire and start paying a contractor, is to collect all necessary documents.
Form W-9: for US-based contractors
The IRS tax form W-9 provides you with your contractor’s personal information and taxpayer identification number (TIN) or social security number (SSN). You need this form if you hire US-based contractors.
Keep the W-9 form in your records for potential tax purposes or IRS audits.
Forms W-8BEN and W-8BEN-E: for foreign contractors
The IRS forms W-8BEN (for individuals) or W-8BEN-E (for business entities) provide you with personal and tax information about foreign contractors or sole proprietorships you hire.
Independent contractor agreement
To protect yourself against liabilities and ensure clear expectations and commitments, sign a written contract—don’t just settle for a verbal one.
Check out our guide on independent contractor agreements for a thorough explanation of how these contracts work.
At its most basic, this document outlines the project’s scope of work, deadlines, and any other clauses that can protect you or the contractor.
It also describes the payment terms between you and your contractor. Contractors may prefer any number of ways to get paid: after major milestones, after the project wraps up, once a month based on an hourly rate, or a fixed rate each week (also called a retainer), just to name a few.
Some contract workers may also require an upfront payment. Before starting the project, come to a firm, written agreement about the contractor’s payment schedule.
2. Determine your tax responsibilities when working with contractors
You don’t need to think about withholding taxes when you make a contractor payment as you would with an employee’s salary. Independent contractors pay their own self-employment taxes, including medicare and social security taxes.
However, you need an accurate Form W-9 (or W-8) in your records. If any information in the form is incorrect or missing—especially the contractor’s TIN—the IRS may instruct you to perform backup withholding.
Backup withholding works like regular employee tax withholding. It’s a safety net for the IRS when they suspect a contractor may not pay self-employment taxes or has a debt they must collect. Backup withholding is rare.
3. Collect invoices from your contractors
Unlike employees who automatically get paid via payroll, independent contractors must invoice their clients as a formal payment request. Your contractor will send you invoices based on your agreed-upon payment cadence.
An invoice typically contains contractor information, your business information, payment details such as the contractor’s bank account number, and details describing the service provided by the contractor and its price.
The due date for payment is 30 days after the contractor submits the invoice. The quicker you pay, the happier your contractor will be.
4. Choose how to pay independent contractors
When it comes to how to pay a contractor, several payment systems and methods are available to you, from crypto to bank transfers, fiat currencies, and even company equity. Each comes with features that may or may not fit your needs, so your preferred contractor payment option will depend on your contractor’s location, pay schedule, rate of pay, and preference.
A wire transfer is a quick and easy payment method that transfers funds between two banks or credit unions. An example of a wire transfer is SWIFT.
However, this payment method can be costly, as both the sender and receiver often pay processing fees. These fees may go up to $50 for international payments. Most companies only use wire transfers to send larger amounts of money less frequently, especially when paying global workers.
ACH direct deposit
ACH stands for the Automated Clearing House network. It refers to sending and receiving money directly from one bank account to another, also called direct deposit.
Over 90% of US residents get paid through direct deposits.
Direct deposits are convenient for recurring payments to local contractors, especially if you’re a busy small business owner using an online payroll system and want to automate your activities. Paying your contractors with direct deposit is also more affordable than other methods, as transfers are all domestic, and cut out intermediaries that charge additional fees.
You can also pay contractors with a credit card, just like you purchase a good or service at a store or online. Remember that a contractor must set up a merchant bank account to receive credit card payments. Contractors who only have a traditional bank account may prefer another payment method.
Credit card payments come with an extra layer of security. Should any disputes arise, resolution time and refunds are quite fast. However, contractors may need to pay a fee (usually ranging between 1.5% and 3.5%) for credit card transactions, although they immediately receive the payment.
Paying a contractor by transferring their payment to a prepaid online or physical debit card is another option. This method is similar to transferring funds to a bank account in that it’s instantaneous.
Some contractors may prefer a debit card if they have issues with their bank or want to keep their freelance earnings separate from their savings.
Deel offers a payment card called Deel Card for contractors who get paid through our platform. They can use the virtual card to make online purchases or even order a physical card.
Money transfer services
Several online services allow fund transfers between businesses and contractors.
PayPal is the most frequent method of transferring money. When using it for business, different fees apply to different situations. PayPal merchant fees can be checked here.
If you have more than one contractor, you can use an advanced business solution called PayPal MassPay. MassPay helps decrease the time needed to pay your contractors since you can make multiple payments simultaneously.
Remember that PayPal has a notable restriction—you can’t use their friends and family option for business purposes.
Payoneer has a global presence and offers multiple options for money withdrawal, including a Payoneer-issued Mastercard. Using this card is faster than waiting for funds to be deposited in regular bank accounts, although Payoneer offers that option as well.
On the downside, Payoneer fees are substantially higher for contractors, with different fees applying to different actions you can perform through your account. You can learn about the details here.
Revolut offers money transfers, deals in gold, and crypto payments. It can handle international transactions with private customers and businesses without hidden fees.
The service also offers customers a card that currently supports up to 130 currencies. You can choose from various subscription options with different fees and products, making Revolut a good choice if your contractor workforce is global.
Formerly known as TransferWise, Wise is a money transfer service with a fair exchange rate, allowing for local bank payouts in multiple currencies. Every other payment service adds a premium to the wholesale exchange rate, making the transaction more expensive, but Wise doesn’t.
They also show rates and fees before transactions are finalized. This is a useful option if you hire multiple contractors.
Many businesses offer to pay their contractors in digital currencies. Cryptocurrencies have many benefits, including a lack of exchange rates and hefty fees.
Crypto is an appealing option for many international contractors and can be a strong recruiting tool.
Deel contractors have the option of using cryptocurrencies as their preferred payment method.
Digital wallets are online accounts that hold money until you withdraw it via one of the methods described above. Digital wallets often come as a part of automated payroll software: you can pay your contractor in just a few clicks (or one click if you use Deel).
The contractor can withdraw their money via SWIFT, direct deposit, crypto, money transfer services, or a pay card—however and whenever they prefer.
Online payments through digital wallets are an excellent option if you have several contractors who all prefer different payment methods.
5. Report payments to independent contractors to the IRS
Although employers don’t cover their contractors’ benefits and taxes, they still need to report contractor payments to the IRS and send the contractor copies of their tax forms.
Employers must report payments to contractors higher than $600 within a tax year, using form 1099-NEC, Copy A.
Until 2020, the form used to report non-employee compensation was Form 1099-MISC. In 2020, the IRS reintroduced Form 1099-NEC, separating it from Box 7 of the 1099-MISC.
The deadline for employers to send form 1099-NEC to contractors is January 31, following the applicable tax year.
Don’t forget to collect the W-9 Form before the end of the year so you’re ready to submit your 1099-NEC on time.
All these forms can be filed electronically.
Pay your entire team in one click with mass payments
Click one button and pay your global team instantly. They can withdraw funds via bank transfers, crypto, PayPal, and more. Easy operations for you, easy options for your team.
6. Make sure you’re not at risk of employee misclassification
Employee misclassification is one of the most common issues when hiring independent contractors. A worker needs to meet specific criteria to be considered a contractor. For example, you can’t control the contractor’s work schedule, require them to work at your office or ask them to work for you exclusively. If you do, you must compensate them like an employee.
The rules regarding worker classification are strict because tax implications differ for employees and contractors.
Employers withhold taxes from their employees’ salaries, costing them significantly more money.
If the IRS decides that your independent contractor should be your employee, you will need to pay Social Security and Medicare taxes (FICA taxes), along with federal and state unemployment taxes. This could be expensive if you planned for an independent contractor relationship.
Draft your agreement with your independent contractors carefully and ask for legal advice to ensure compliance and avoid penalties. If your contractor starts to resemble an employee, you should rethink your business relationship and offer them a full-time contract.
If you are still in doubt about the nature of your working relationship, you can consider submitting form SS-8 to the IRS. This will prompt the IRS to review the case and make an official determination.
Or, you can use Deel Shield to ensure your business is always safe from misclassification and its penalties.
Pay contractors timely and accurately with Deel
Even if you manage many local and international contractors, paying them doesn’t need to be challenging if you identify the proper method to manage your workers and payments in one place.
Deel is an all-in-one, self-service platform that lets you handle your entire payroll (employees and contractors) in one click with our mass payments option.
It saves you time, provides security, and allows your contractors (and employees) to use multiple withdrawal methods to access their pay.
Read more about how Deel can streamline your payroll or book a demo to see how we can help you and your team grow.