Ultimate Guide on How to Pay Contractors (2021)


Quick Read

Looking to hire an independent contractor? Take a look at our guide on paying contractors for all of the information you need. Here at G.E. Payroll, we have been in the payroll industry since 1993. We want to share that expertise with you. That’s why we cover:

  • How you can determine if a worker is an employee or independent contractor with this test from the IRS.
  • Everything you need to know about what should be in your contractor payment agreement; from all of the fees that should be specified to the scenarios that should be laid out.
  • Whether or not to withhold income for contractors and when exceptions should be made.
  • How and where to report contractor payments with the 1099-NEC Form.

With this info, you are ready to properly manage contractors and take your out-sourcing to the next level. Be sure to look towards G.E. Payroll as your answer for managing payroll for your company, as well as human resources and time & attendance. Get your free demo today!

Contractors are a great way to get specific projects done without hiring a permanent employee or having a current employee without the expertise to do it. The question does come up of how to pay and manage independent contractors. Before you hire an independent contractor, take a look at this ultimate guide on paying contractors.

What Qualifies as an Independent Contractor

The first step, and one that is more difficult than you may expect, is determining whether a worker qualifies as an independent contractor. You’ll have to determine this on a case-by-case basis.

To make this simpler, the IRS has put out a test that you can find here. This is called the 20-Factor Test and consists of 20 yes-or-no questions that can help you make the determination that a worker is independent enough to be considered a contractor, or you have enough control that they are considered an employee. You can get an in-depth manual for that test through your local IRS center. A high number of “yes” answers on this test means that the worker is most likely an independent contractor, while many “no” answers would mean that they very well may be an employee.

Keep in mind that this isn’t a foolproof system. The best way to know for sure is by pursuing an IRS ruling to get an official determination.

Contractor Payment Agreement

While a verbal contract is just as valid as a written contract, it is still good to get as many details as possible in writing to avoid any miscommunications. Here are some of the most important pieces of information to include:

  • How much the payment will be and whether the payment will be hourly or by the job.
  • How often a payment would be due if this is a recurring service being provided.
  • If there is a minimum amount that will be due. This is only applicable to those being paid hourly.
  • Any additional fees that may arise.
  • For by the job pay, any milestones or deadlines that will result in payment when met.
  • What reports about the job will be due and when.
  • Whether subcontractors will be allowed.
  • What will happen if the work is not completed in time.
  • What will happen if the payments are not made on time.
  • What will happen if the work that is done is not done correctly.

Be sure to determine all of this and have it agreed upon before any work gets done. It is much harder to make a determination about these terms after any amount of work has been completed.

Withholding Income for Contractors

For most contractors, you don’t have to withhold income when filing payroll taxes. Independent contractors will pay the full amount when filing their taxes.

While this is the case for almost every independent contractor, there are a few exceptions. If you have workers that qualify as independent contractors but fall under certain conditions, they should be treated as employees. These are called statutory employees. You can find those conditions here.

You may have to have backup withholdings in place. This will happen when the IRS directs you through a backup withholding notice as a result of incorrect information on the W-9, specifically the taxpayer ID. When this happens you will have to withhold the backup withholding rate of 24% by filing Form 945.

Reporting Contractor Payments

While you don’t have to withhold any income for independent contractors, that doesn’t mean that you don’t have to report them. You will generally have to report your payment by filing a Form 1099-NEC if you meet the following four conditions, per the IRS:

  • The payment in question was made to someone who is not your employee
  • You made that payment in the course of your trade or business, including government or nonprofit work.
  • That payment was made to an individual, partnership, estate, or corporation.
  • Your payment or payments to that recipient exceeded an amount of at least $600 during the year.

Keep in mind that, while 1099-MISC forms used to be the way to report payments to contractors, they no longer are. Do not use a Form 1099-MISC to report any non-employee payment.

How G.E. Payroll Can Help

This can be a lot to manage. In fact, most payroll can be difficult to manage, especially for small businesses that don’t have a department set up specifically to manage payroll. If you’re looking to manage your payroll to make paying independent contractors and the rest of your employees easy, look toward G.E. Payroll Software. On top of payroll management, you can take advantage of our Human Resources and Time & Attendance features.

To learn more or ask any questions, you can call us at (434) 426-0134 or fill out our contact form. If you want to experience our software yourself with no obligation necessary, request your demo today.

PLEASE NOTE: While we have researched this page extensively, and believe all statements to be accurate, you should still consult with your tax counsel before making any decision

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