How to Pay Contractors in 3 Easy Steps

July 26, 2022
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Business Basics

So, you recently started a business - congratulations! But all of the sudden, there's a lot more work for you to keep up with than you anticipated. You're looking to outsource some of your workload to a contractor or two in order to grow your business (and keep sane while you're at it).

Maybe you've been in business for a while and you're just tired of your accountant yelling at you for using Venmo to pay contractors. There's got to be a better way.

But, what exactly is a contractor? More importantly, how do you pay contractors as a business owner?

1. Define what an independent contractor is

Believe it or not, the definition of what classifies someone as an independent contractor can get really muddy. Generally, there are two ways of hiring people to do work for your business: as an employee or as an independent contractor. Unfortunately, getting this distinction wrong can result in legal issues and fines. For that reason, it's important to consult an employment lawyer if you're unsure and never take an online blog post (like this one) as legal advice.

The IRS states: "The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done."

Essentially, your business can only control the end product or result, not how the work gets done. In contrast, employers have the right to control the details of how services are performed; when you hire an employee, the business is able to dictate the process that gets used to complete the work. There are federal and oftentimes state directives to determine the distinction between employees and contractors. The IRS uses something called "Common Law Rules" to help business owners weigh whether or not a worker is an employee or independent contractor:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee-type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Once again, if you're unsure about whether or not you should be hiring a worker as an employee or an independent contractor, contact a local employment lawyer.

2. Collect the right information

What's needed to properly pay an independent contractor?

An often overlooked aspect of paying contractors is collecting the correct tax information. If you're paying someone at least $600 over the course of a year, you'll need to file form 1099 with the IRS. This can sound intimidating, but it really just means collecting some basic information. Most bookkeeping software like QuickBooks online can even help you track and submit 1099s automatically!

To issue form 1099, you'll need to collect tax-related information from your contractor. This is easily done by simply sending your contractor form W9 to fill out.

Form W9 is a request for your contractor's taxpayer identification number: either a Social Security Number or an Employee Identification Number. This form allows you to collect basic information about your contractor like their address, city and state, their business name, and whether or not they've incorporated as an LLC, corporation, or another type of entity. All of these fields are used when filing form 1099 with the IRS.

Many new business owners get confused over the difference between these two forms, which is completely understandable! What's the difference between a W9 and a 1099?

Form W9 is an internal record for your business that details information about an independent contractor; it does not need to be filed with the IRS at the end of the year.

Form 1099 is an informational report filed with the IRS stating the amount of money your business paid to an independent contractor over the course of a year.

Since form 1099 is a report of payments made over the course of the year, you as the business owner are responsible for keeping a record of the amounts that you pay to your contractor. Keeping a running total is an important aspect of reporting the correct amount that you've paid over the year. While this can sound incredibly intimidating, most accounting software makes it easy to track payments to vendors!

Working with a bookkeeper or accountant can simplify the process of tracking payments and filing 1099s at the end of the year and ensure that you have one less thing to worry about.

3. Choose your payment platform

As I mentioned before, it's incredibly important to track the amount of money that you're paying to your workers so that you can properly report the amounts to the IRS on form 1099. It can feel incredibly overwhelming to track all of that information by hand.

Luckily, there are several apps that can make your life easier!

First, what not to use: don't use Venmo to pay contractors. There are several reasons why, but the biggest one is because it's too easy to blend your personal finances with your business when doing so.

So, what apps should I use to pay contractors?

  1. Melio (FREE): Melio is a free way to send payments to your contractors and track 1099s for free. You can issue checks, direct deposits, and even receive payments. It’s extremely easy to use and it makes tracking a breeze.
  2. Bill.com (+$45/month): A great albeit pricey solution for payments. Bill.com is usually great for businesses with a high volume of bills to be paid.
  3. QuickBooks (+$25/month): If you’re already using QuickBooks for your bookkeeping needs (or you’re having us take care of it for you), you can use it to track 1099 payments. When tax time comes, you can easily have those 1099s sent out to contractors automatically, too!
  4. Gusto (+$6/person): Whether or not you’re paying yourself a regular salary, Gusto is a great option for paying independent contractors cheaply and efficiently. They’ll track your 1099s as well!
  5. Relay (FREE or $30/month): Relay is actually a business banking platform that's beloved by accountants. It's fully online, allows you to issue multiple bank cards, and has a full bill pay platform, W9 requests, tracking for 1099s, and more. Plus, it syncs directly to your accounting system.

Regardless of how you pay contractors, the most important thing to do is track the payments that you've made. There are so many platforms you can use today to collect the information and streamline this aspect of your business! Work directly with your accountant or bookkeeper to ensure that you have an excellent solution put into place.

Jeremy Millar
Written by:
Jeremy Millar

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