1099 Payroll: How to Pay Independent Contractors

Paying independent contractors can be tricky. In most cases, it’s not the act of sending money that requires significant effort. Rather, it’s the process of accounting for all the variables that change when new situations arise.

But before worrying about how to pay independent contractors, business owners have to determine if their team members are actually contractors or freelancers.

A company that incorrectly categorizes its workers as independent contractors can face expensive legal consequences. More importantly, it is considered a criminal offense if the IRS discovers that you misclassified your workers on purpose.

So how can you tell if your team members should be classified as contractors or employees?

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1099 Independent contractors vs. remote employees

The IRS has a set of guidelines that differentiate an employee from a 1099 contractor.

Businesses need to review these guidelines to make sure they comply with federal tax regulations. Worker classification will determine whether a company needs to withhold income taxes, Medicare taxes, and unemployment tax on wages or not.

To make things simpler, answer these three questions about your workers:

Will they be required to undergo a formal onboarding or training program?
Are there specific tools they need to use or guidelines to follow?
Is there a specific number of hours that they need to meet weekly?

If you answered “yes” to any two questions, they should be legally classified as employees. In that case, you’re responsible for withholding taxes on their wages.

The key point to remember is that employees must follow pre-established procedures and schedules to do their work. With independent contractors, the results are all that matters. How and when they want to do the job is up to them.

1099 contractors may have more freedom in the way they work, but there’s a trade-off. Since you won’t be hiring them as regular employees, they’ll be in charge of paying their own taxes, Social Security, and other fees that employers typically withhold.

Since contractors pay all these things themselves, they’re considered self-employed professionals.

We’ll get into fees and deductions in a bit.

How to pay independent contractors: Payment methods

Looking for a reliable way to pay independent contractors? Here are the top four payment options:

1. Online payment systems

The convenience and security of online payment systems make them a popular choice among both contractors and employers. They often offer powerful integrations with popular accounting, communication, and customer service tools.

PayPal

PayPal is the largest online payments processor in the world, with over 325 million active users in 202 countries and 25 supported currencies.

Businesses around the world use PayPal to pay contractors and team members. This means that if you want to outsource talent, there is a solid chance that the independent contractor you end up hiring already uses the platform.

PayPal emphasizes security and automatically encrypts confidential information when storing and transmitting it.

Keep in mind that, even though most people around the world can receive payments via the platform, not all countries have the option to withdraw funds to a local bank account via wire transfer.

As a result, you may end up paying your international team members overseas only for them to get stuck with balances that they can only use for online purchases.

Payoneer

Payoneer allows businesses to send payments to contractors through direct deposit. It’s available in more than 200 countries and supports over 150 currencies. The company is a regulated entity in the US and EU and is licensed to remit funds globally.

Payoneer gives contractors multiple ways to withdraw their earnings, including using Payoneer’s prepaid Mastercard cards and global bank wire transfers. They always follow the strictest security practices to ensure your data and funds stay safe.

Wise

Wise leads with a pretty compelling offer: the fairest exchange rate possible. Unlike other payment platforms, Wise doesn’t add a premium to the wholesale (mid-market) exchange rate. That means you end up paying only what you have to for currency conversion.

Like Payoneer, Wise offers a debit card users can use to withdraw or spend funds once they get paid. The platform also follows strict security regulations that ensure your data and funds are secure.

Sadly, Wise is only available in 60 countries. If you have contractors outside of those 60 countries, you’ll need to look for a different payment service.

Hubstaff

The best way to pay independent contractors online is to streamline their work tracking with an automated payroll system.

Hubstaff is a time tracking and payroll software that addresses the main challenge mentioned above: ensuring that you get value for your money. Hubstaff tracks every hour worked so you know exactly how much you will pay.

Ditch paper checks and use Hubstaff to pay independent contractors, remote team members, or freelancers. Hubstaff offers an online payment solution that can be maintained right from within your account by integrating with international payment platforms like PayPal, TransferWise, Bitwage, and Payoneer.

But Hubstaff isn’t just a payroll tool. It can also track time automatically and maintain a record of which time logs you’ve paid and which ones you haven’t.

Hubstaff simplifies time tracking and adds an extra layer of insight and reporting. Payments can be sent out automatically or manually. All your contractors have to do is download the desktop app and press start to track time. From there, Hubstaff will automatically calculate payroll based on team members’ hourly rate and time logged.

You can also use Hubstaff’s time reporting feature to view how many total hours they have worked over a specific date range and pay them accordingly upon project completion. It even integrates with accounting software solutions like QuickBooks and FreshBooks to simplify your accounting process.

Other benefits of using Hubstaff include more accurate project budgeting and automated scheduling and attendance reporting. As an added bonus, Hubstaff offers tools to help you measure productivity and create proof of work for independent contractors and distributed team members.

Hubstaff creates more visibility into what’s getting done by showing you which apps and URLs your team uses, tracking activity scores, and allowing you to configure optional screenshots to help you spot the source of productivity problems.

2. Direct deposit

Direct deposit is arguably the most accessible payment method because all you need is a bank account — which almost every contractor looking for a job probably already has. Several contractors opt for direct deposits if for no other reason than they’ve counted on it for a long time.

However, there is a huge downside to this: you can only perform transactions in your local currency. This means that if you strictly intend to utilize direct deposits only, you’re effectively closing the door on international talent when you’re hiring contractors.

Also, paying via direct deposit can make for a lot of manual work. For instance, you’ll need to determine and manually calculate (or pay someone else to calculate) the contractor’s timesheet before a payment can be processed.

Even if you stick to a fixed-price-only approach during the hiring process, you’re not going to pay the same exact amount of money after every task or project. The admin work will always be a challenge when it comes to direct deposits — unless you consider a time tracking app with payroll integrations.

Accurate timesheets with less admin work

With Hubstaff’s free trial, payroll integrations help you turn tracked time into direct deposits.

3. Wire transfer

Wire transfers essentially work the same way that direct deposits do — except for the fact that they let you send money overseas to your independent contractors. Receivers are required to provide personal information that matches the details provided by the sender. Because of this added security measure, wire transfers are extremely safe.

With wire transfer systems like Moneygram and Western Union, you can securely send payments to contractors around the world. They can wire the money directly to their bank account and choose to receive cash in person.

The biggest weakness in wire transfers is that they can take time to process. Sometimes it can take several days for a contractor to see the payment reflected in their bank account. This can lead to some uneasiness and fear on the receiver’s part.

Like direct deposits, they also require manual work. If you plan to hire a significant number of contractors, keep this in mind. You’ll be spending several hours processing payments to each of your contractors instead of getting quality work done, which can lead to profit loss. Because of this, the wire transfer method quickly becomes less and less viable as your team grows.

4. Freelance/remote job sites

Last but not least is freelancing sites. These sites usually have their own payment systems to make transactions between employers and freelancers as seamless as possible. If you’ve hired a contractor through a freelancing site, chances are you know the drill: convenient payments are possible, but they come at a cost.

The idea looks good on paper, and for most freelancing sites, the process is secure and painless. You deposit money into your employer account, hire a contractor, and then the platform pulls the money from you to the freelancer once the job is finished.

However, most freelancing platforms charge payment processing fees. These may not seem like a lot initially, but they can add up to drastic amounts over time.

Take Upwork, for example. Upwork charges a flat 3% charge for all your payments. If you hired 10 contractors and paid them $1000 each, you’ll have to pay a total fee of $30 — just for using the platform.

The good news is that there are freelancing sites that are completely free to use, like Hubstaff Talent. You’ll still have the benefit of having access to thousands of freelancers worldwide but without any of the fees.

What else do you need to comply with when paying independent contractors?

When paying independent contractors, it’s crucial that you understand which IRS tax forms to prepare, what kind of fees you need to withhold, and which types of deductions you’re eligible for at the end of the year.

What forms should employers have for independent contractors?

According to the IRS, there are two forms that business owners need to prepare: Form W-9 and Form 1099-NEC. Here’s what these forms are:

Form W-9 (Request for Taxpayer Identification Number and Certification)

An independent contractor must fill out the W-9 form to confirm their name and Taxpayer Identification Number. You don’t need to submit W-9 forms to the IRS — a W-9 form is primarily for verification purposes and future references.

Form 1099-NEC (Non-employee Compensation)

The IRS requires you to submit a Form 1099-NEC if you made a payment of more than $600 for the professional services of an individual or business entity that year.

Correctly classifying workers is extremely important. Make sure that whoever you’re filing this form for qualifies as an independent contractor.

Withholding fees and deductions for independent contractors

As previously mentioned, independent contractors are considered self-employed. You’re not required to withhold taxes and other fees you would normally pay for regular employees.

Regardless of the payment terms that you have agreed on, the money that you pay your contractors will be counted as tax-deductible expenses. This amount will be subtracted from your business’ income before it becomes subject to taxation.

The amount in question isn’t restricted to payments made for the contractor’s work. Depending on the agreement between you and said contractor, this could also include additional expenses and deductions such as:

Laptops, office chairs, and other work supplies
Monthly allowances for work (i.e. essential utilities like internet bills, membership fees, etc.)
Contractor’s business-related travel expenses

Let’s say you’re having a retreat for your remote team. There are several other kinds of contractor-related expenses you might incur. You can classify them as tax-deductible expenses in most cases — as long as you can prove that they’re necessary for your business to make a profit.

Which payment method should you use to pay independent contractors?

When making a financial decision on how to send payments to contractors, you shouldn’t base your decision on which platform is the cheapest.

Make sure that you select the most convenient one for your business — but only if it supports all the countries and territories where your contractors are based. Convenience without compliance may end up costing you in the long run.

Simplify time tracking and payroll with Hubstaff Time

Easy, accurate timesheets without the headache.

FAQs

How do you pay an independent contractor?

In most cases, independent contractor payments will be made on a per-project or hourly basis.

Of course, there are some options that fall somewhere in between. These include partial payments when a project reaches a specific milestone or when the contractor has reached a certain number of working hours. Because they aren’t hired as full-time employees, you would simply pay whatever the total amount is without any further computations.

Can you pay contractors through payroll?

Yes. You can include contractors in your payroll since the process is the same. The difference is that you need to perform deductions to your full-time employees’ pay before paying them, but this isn’t required at all with contractors. You would pay the whole amount.

What are typical payment terms for contractors?

Contractors are usually paid under Net 10/30/60 credit terms. Net 10 means that the invoice must be paid in 10 days, Net 30 in 30 days, and so forth. Contractors usually opt for shorter credit terms like Net 10 (or even 7) for newer clients and longer terms for more trusted ones.

What is the safest way to pay a contractor?

Most modern payment methods offer incredible security and reliability. The best answer to this question isn’t actually any particular payment platform, but actions you can perform to ensure that your payments are carried out securely.

For starters, you need to verify that the bank details provided by the contractor match their personal information. Triple check that they are who they say they are. Do not agree to shady payment terms like cash in person or Visa gift checks because they offer no protection whatsoever.

You can avoid major security issues just by following these simple steps.

Understanding the employer/contractor relationship

Well, there you have it. Whether you’re an employer or employee, understanding the employer-contractor relationship can be difficult — but it doesn’t have to be.

Small business owners may need to spend a few extra business days on their end-of-year bookkeeping. Similarly, contractors might want to read up on self-employment taxes.

Were you able to determine which of the payment methods mentioned above is best for your company? Are there any payment platforms that you use that are worth mentioning? Let us know in the comments below.

If you have additional questions about money transfers and payroll, check out our other articles:

This post was originally published in December 2014. It has been updated in March 2022 for accuracy and more relevant payment systems.

How to Pay Independent Contractors: A guide

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1099 Independent contractors vs. remote employees