payroll

1099 Payroll: How to Pay Contractors in 6 Legal, Hassle-Free Steps

Contractors don’t get paid the same way as salaried employees. Here are the best ways to pay your local and international contractors hassle-free.

Anja Simic
Written by Anja Simic
September 17, 2021
Contents
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Independent contractors are self-employed individuals who work with companies as clients, usually on specific projects for a limited amount of time. Unlike employees, who typically work for a single employer, contractors often work with several clients at a time and manage their own taxes, schedules, and tools for work.

Independent contractors, sometimes called freelancers, offer many benefits, especially for companies that have fluctuating workloads or want to trial a potential employee. Contractors are also more affordable than regular employees: they provide their own tools and equipment and don’t receive employer benefits or payroll tax contributions.

But companies don’t pay contractors through regular employee payroll. In this article, we’ll walk you through the six steps to take to pay your local and international contractors.

1. Collect necessary documents before you start working with contractors

Before you hire and pay your contractor, you must collect a few 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 define the expectations from the contractor, sign a written agreement—don’t just settle for a verbal one.

Check out our guide on independent contractor agreements for a thorough explanation of this contract. But at its most basic, the 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. Come to a firm, written agreement about the contractor’s payment schedule before starting the project.

2. Determine your tax responsibilities when working with contractors

Companies don’t need to pay taxes when working with independent contractors. You don't need to withhold any taxes when you make a contractor payment as you would do 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 need to invoice their clients as a formal payment request. Your contractor will send you an invoice based on your agreed-upon payment cadence.

The 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 the 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

Every payment system has its pros and cons: some take a few business days to complete, some have high transfer fees, and others lack security. The payment option you choose depends on your contractor’s location, pay schedule, rate of pay, and preference.

Wire transfer

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 method of payment 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 to pay 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, 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. The transfers are all domestic and cut out intermediaries that charge additional fees.

Credit card

You can also pay contractors with a credit card, just like you purchase a good or service at the store or online. A contractor needs to set up a merchant bank account to receive credit card payments, so contractors who only have a traditional bank account may prefer another payment method.

Credit card payments come with a layer of security. Should any disputes arise, the resolution time or refunds are quite fast. Contractors may need to pay a 3% fee for credit card transactions, but they immediately receive the payment.

Debit card

You can pay a contractor by moving their payment to a prepaid online or physical debit card. This method is similar to transferring funds to a bank account in that it’s instantaneous. But some contractors may prefer to load a debit card if they have issues with their bank, or want to keep their freelance earnings separate from their savings.

Deel offers a pay card called Deel Card for contractors who get paid through our platform. They can use the virtual card to make online purchases, or order a physical card to use it for physical purchases.

Money transfer services

A few online services also allow fund transfers between businesses and contractors.

PayPal

PayPal is the most frequent method of transferring money. Fees are also quite low, 2.9% + $0.30 in the US.

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 all of your contractors since you can make multiple payments at once. Remember that PayPal has a notable restriction—you can’t use their friends and family option for business purposes.

Payoneer

Payoneer has a global presence and offers multiple options for money withdrawal, one of them being a Mastercard issued by Payoneer. Using this card is faster than waiting for the funds to be deposited on regular bank accounts, although Payoneer offers that option as well.

On the downside, Payoneer fees are also substantially higher for contractors. They need to pay $2-4 to load the debit card, additional fees for transferring the money to a local bank account depending on the transfer’s size, and up to 3.5% for currency conversion.

Revolut

Revolut offers money transfers, deals in gold, and crypto payments. It can handle international transactions to private customers and businesses with no 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.

Wise

Formerly known as TransferWise, Wise is a money transfer service with a pretty 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 sending the money, so it’s a good choice if you hire multiple contractors.

Cryptocurrency

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 contractor recruiting tool.

Deel contractors have the option of using cryptocurrencies as their preferred payment method.

Digital wallets

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 a few clicks (or one click if you use Deel). Then, the contractor withdraws 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

Although employers don’t cover their contractors’ benefits and taxes, they still need to report the contractor payments to the IRS and send the contractor copies of their tax forms.

Employers need to report the payments made to contractors higher than $600 within a tax year using form 1099-NEC, Copy A. Until 2020, the form used to report the 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 the form 1099-NEC form 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. You can file all these forms electronically.

6. Make sure you're not at risk of the employee misclassification

Employee misclassification is one of the most common issues when hiring independent contractors. A worker needs to meet certain 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 are different 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 in fact be your employee, you need to pay Social Security and Medicare taxes (FICA taxes), along with federal and state unemployment taxes.

Draft your agreement with the independent contractor 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.

Use our employment calculator to estimate your overall employer costs for employees in multiple countries.

Pay contractors timely and accurately with Deel

These getting-started steps give you a process to provide accurate and timely payments to your contractors. Even if you manage many local and international contractors, paying them doesn’t need to be challenging if you identify the right method to manage your workers and payments in one place.

Enter Deel.

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.

Deel makes growing remote and international teams effortless. Ready to get started?

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