- Independent contractors work for small businesses based on a contractor agreement but aren’t considered employees.
- Hiring independent contractors can be a way for small business owners to add to their workforce without necessarily hiring employees.
- There are federal and state laws governing what separates contractors from employees, how they can be paid, and how their taxes are filed for the IRS.
- Learn more about how to pay independent contractors in this article from Nav’s experts.
What Is an Independent Contractor?
An independent contractor is an individual that a business hires via contract to perform work or duties for the business. They are typically self-employed individuals or freelancers who may work on a part-time basis for the company. Many small businesses use independent contractors to round out their workforces when they can’t justify a full-time role or need work done for a specific project, such as web development, copywriting, telemarketing, or social media management. Licensed professionals such as lawyers, dentists, physicians, veterinarians, and accountants may also work as independent contractors.
While an employee and an independent contractor may fulfill similar or even the same duties, there are some distinct differences between the two. Many agencies, such as the Internal Revenue Service (IRS), Department of Labor, and state and local governments, may have different laws or requirements regarding the classification of employees vs independent contractors, so it’s important to know the difference.
The biggest difference is that a company pays an employee’s taxes, such as income tax, federal withholding, Social Security taxes, and Medicare, based on how much the employee earns in wages. An independent contractor must pay their own taxes and report their earnings to the federal and state government every year. Often independent contractors will pay their taxes on a quarterly basis as opposed to by paycheck.
Other major differences between an employee and an independent contractor are:
|Independent Contractors||Regular Employees|
|Use their own equipment such as computers, phones, cars, or tools.||Use employer-issued tools such as computers, phones, tools, or cars.|
|Determine their own hours and where they work.||Can be required to work from a set location or during set hours by their employer.|
|Do not generally rely on a single workplace for all of their income.||May only work for one employer.|
|Are not held to regulations with regard to minimum wage, breaks, or overtime.||Must be paid at least minimum wage, be provided with breaks, and be paid for overtime.|
|Not eligible for employer benefits.||May be eligible for employer benefits such as health insurance or retirement plans depending on state law.|
|Often paid on a per-project or hourly basis.||Often paid on a salary or hourly basis.|
Many state laws outline exactly how an employee must be treated as opposed to an independent contractor, and employers can face dire consequences if they misclassify workers. For instance, the California Supreme Court made a ruling in 2018 that made it much more difficult for employers to classify workers as independent contractors. The ruling was part of a broader attempt to stop abuses against gig workers as they grew as part of the workforce, and employers who misclassified their workers could face stiff fees. Employers may also be required to pay overtime for misclassified workers under the Department of Labor’s Fair Labor Standards Act (FLSA).
If an independent contractor is unsure of their status, they can file a Form SS-8 with the IRS to help determine which one they are and how they should be paid and file taxes.
How Are Independent Contractors Usually Paid?
When small businesses pay contractors, they generally do so on an hourly basis or on a per-project basis. When outlining the contract, the business, and the worker will agree on a schedule of payments, a pay rate (an hourly rate or per-project rate), a payment method, and the scope of the work. They will often outline a statement of work (SOW) that states clearly what the contractor’s roles and responsibilities are and the deliverables of the work they are to do.
The contractor will complete a Form W-9 for the business, which is a request for taxpayer identification. If the independent contractor has a business structure such as a limited liability company (LLC), they’ll supply their business details, such as:
- Employee identification number (EIN) or taxpayer identification number
- Business address
- Business name
Any bank account information or other payment method details.If the contractor doesn’t have a business entity, they’ll use their Social Security number as a tax ID number.
A contractor may submit an invoice when work is completed or on a time tracking basis, such as weekly or monthly. The invoice will include agreed upon payment terms, such as pay rates and work. Depending on their written contract, the business may pay the contractor through a number of payment options, including check, Automated Clearing House (ACH) deposit, wire transfers, or direct deposit to their bank account. Some contractors may prefer online payments through services like PayPal or Venmo, or even via prepaid credit cards. Many contracted workers are paid like vendors or suppliers through the business’s accounts payable department.
Taxes and Independent Contractors: Who Is Responsible for Paying?
All independent contractors are responsible for paying their self-employment taxes on a quarterly basis. Total federal payroll taxes for self-employed individuals will add up to 15.3% of their total earnings (12.4% for Social Security and 2.9% for Medicare). They can pay their estimated taxes every three months using IRS Form 1040-ES, the Estimated Tax for Individuals. They should also be prepared to pay local or state taxes.
In some cases, the paying business will need to deduct some taxes from the contractor’s payment. This is called “backup withholding” and usually only happens when a freelancer gives the wrong tax identification number or they don’t report the right income on their tax return.
What Is a Form 1099?
The IRS Form 1099 is a set of tax forms that a payer fills out and files with the IRS to report payment for something other than employment on an annual basis. If you pay a contractor more than $600 in a year, you must report this payment to the IRS, and the independent contractor must also include it in their income tax return. The form must be filled out and sent to both the contractor and the IRS by January 31 each year.
The most common types of this form are:
- Form 1099-NEC — “NEC” stands for “non-employee compensation” and reports how much the business paid non-employees (including independent contractors) for the year
- Form 1099-MISC — “MISC” stands for “miscellaneous” and includes reports of a business’s miscellaneous payments, like rent
- Form 1099-K — this reports card transactions the company paid through third-party networks
Using a Payroll Software System to Pay Independent Contractors
Payroll software and payroll services can help a small business stay organized and manage paying independent contractors. If you decide to use your payroll software or service to pay non-employees, you need to make sure your system can differentiate between employees and contractors so that you don’t run into problems withholding taxes.
There are a few other considerations for using a payroll system or payroll software to pay independent contractors.
- Easy for contracted workers to input their information
- Payments can be generated automatically
- Easy to keep track of payroll records
- Generate tax forms like Forms 1099-NEC and 1099-MISC automatically
- File Forms 1099 and tax reports automatically
- Keep track of contractor pay through reporting
- Reduce errors in data entry
- You may have to run payment processing for both employee payroll and independent contractors at the same time
- You may need to have a separate payroll system for independent contractors
- Software or system may require longer processing time for independent contractors
- Have to be careful about ensuring contracted workers aren’t misclassified
Best Payroll Software for Paying Independent Contractors
There are several payroll software options available for small businesses who wish to pay independent contractors. Finding the right payroll software or payroll service for your business is easier if you use Nav. We give you curated suggestions based on your business data. You can also check out our payroll services resources to compare options.
Online Payroll by Intuit QuickBooks
What is the safest way to pay a contractor?
The safest way to pay an independent contractor is usually through official means, including checks, direct deposit, or credit cards. You want to be able to keep track of how much you paid a contractor and when, and digital payments can help you keep records easily. Paying a contractor through cash is the least safe option.
How do independent contractors take payments?
Depending on the written contract, an independent contractor may take payment from your business in a number of ways. Some popular methods include:
- Direct deposit
- Credit card
- Wire transfer
- Online payment (Zelle, Venmo, Paypal)
How do I pay taxes for independent contractors?
Because independent contractors are responsible for paying their own self-employment taxes, your business will not have to pay taxes for them (except in instances where the contractor provided the wrong tax identification number, in which case you may be required to pay backup withholding). Instead, you will file a Form 1099 with the IRS and send a copy to the independent contractor to report how much you paid them in a given year. It’s then their responsibility to file their taxes with the IRS.
Can I use Zelle to pay independent contractors?
Yes, you can use Zelle to send money to an independent contractor, as long as you are both signed up to use Zelle.
Can I use Cash App to pay independent contractors?
Yes, you can use Cash App to pay independent contractors, as long as you are both signed up for the service. You will need to make sure you have enough money in your bank account and make sure you report the payments to the IRS through a Form 1099. Also, be aware that Cash App may not provide fraud protection like other payment systems.