How To Pay Independent Contractors In 5 Steps
Paying independent contractors is different from paying full time employees..
In most cases though, it’s easier because with contractors you don’t pay or withhold taxes. Plus, labor laws don’t extensively cover them as they do employees. The payment process is even more straightforward if you incorporate a digital bill payment solution such as Melio. But first, you need to decide whether you want to process payments in-house or via a payment software.
If you decide to use a digital bill payment solution, your independent contractor needs to fill out the W-9 form. The W-9 forms contain their personal information, such as the name and social security number. Even though you are not required to withhold their taxes, all federal, state, and local tax laws apply. As far as payment, there are different methods you can use, such as cash, checks, or a digital tool. As the employer, you’ll also have to fill the Form 1099-NEC, Nonemployee Compensation, and send it to the contractor, IRS, and state tax agency. The only time you may withhold tax is if the independent contractor provides a fake social security number (doesn't usually happen, but you never know).
Step by Step Guide on How to Pay Independent Contractors
1. Independent Contractor Payment Method
When it comes to payment, you need to consider the pay rate, payment frequency, and the payroll system. First of all, you need to have an agreement with the independent contractor before engagement. The deal includes the pay rate and how often you pay them. Usually, independent contractors are engaged on per hourly or per-project basis. That will help you determine how much they get paid once they complete the task. Even as you calculate the desirable payment per project, remember they are required to submit self-employment tax. The self-employment tax is typically double what employees pay.
The payment schedule you choose should be determined by the type of project the contractor is undertaking. That said, you should still be flexible enough because the contractor is self-employed. Independent contracts pay between 15.3% and 18.2%, but this amount increases because of additional taxes. Just like the rest of us, independent contractors pay federal, state, and sometimes local taxes. Once you agree on the payment schedule, payment method, and project completion date, you may now sign a contract. The contract agreement secures the entire process.
2. Collect W-9 Form
The primary function of the W-9 form is to gather information about a person. The personal information includes their full names, birth date, and of course, their social security number. The independent contractor fills the form before working on the project. Again, you’ll use the W-9 form to fill the Form 1099-NEC annual report as required by the IRS. But.. what if the independent contractor refuses or shares fake information on the W-9 Form? In such a case, the IRS will contact you and give you the authority to withhold taxes for the independent contractor. Instead of the regular tax, they are supposed to pay 24% as withholding backup. Be sure to keep the W-9 records for a minimum of three years. It’s good to note that the W-9 Forms are categorized differently, determining how you fill Form 1099. W-9 forms have classification as a sole proprietorship, corp, etc.
3. Set-Up Contractor In Digital Bill Payment Platform
Now that you've collected the necessary forms, you’ll use the W-9 Form to set up the independent contractor on your bill payment system. The payroll could be a notebook, Microsoft Excel, or proprietary software such as Melio. Proprietary software comes in handy, especially if you are paying multiple contractors, and don't forget that your payroll software of choice needs to be connected with your bank account. Furthermore, you need to create the payments account for each of the contractors (if you have multiple).
In most cases, processing payments is easier when the contractor fills in ALL of their information. However, if possible, you can fill it for them. Usually, well-designed payroll software will allow you to import spreadsheets with contractor’s records. Also, some payment systems come with QuickBooks integration that enables you to import payment records directly into the system. In such a case, your tech team will have to enforce the integration for smooth transfers. Of course, the integration requires a prior understanding of the software documentation. Whichever method you choose, you are good to go with the digital bill payment platform.
4. Processing Payment for Independent Contractors
Once you’ve set up the digital bill payment solution, you can now wait for the first payment schedule. Or, if you had agreed on a deposit, then process that. You typically have several deposit options to choose from, including:
- Wire Transfers
- Credit/Debit cards
- Automated clearinghouse (“ACH”)
From there, the contractors receive their payment via the following methods:
- Paper check
- Electronic check
- Debit card
- ACH transfer
- Wire transfer
- Virtual Card Number (“VCN”)
Note that payment methods (direct deposit) take up to four days to process. Additionally, it will cost you extra to use direct deposits if you are not enrolled in payroll services. If you are processing only a few payments, then you can try printing checks for free online. The good thing is that most bill payment solutions offer direct deposit for free. On the other hand, prominent payroll companies provide pay cards. Payments are then processed once you enter the contractor’s details, but you need to check on the platform to confirm the correct payment procedure.
5. Prepare Your 1099 Tax Documents
According to tax requirements, you need to fill in Form 1099-NEC, Nonemployee Compensation- a report of payments made to independent contractors. You need to fill the form annually and submit it to the IRS. In this form, you’ll report any contractors you’ve paid more than USD $600 total. Afterward, you need to send copies of the 1099 forms to each contractor. The other copies you send to the IRS and state tax agency with the amount you paid. It's also advised to keep copies for record-keeping.
The deadline for submitting most of these forms to the IRS is set on 31st January each year. When you do, you’ll find the contractor’s information from the W-9 forms each contractor filled initially. Remember- each contractor’s details need to be accurate, to prevent risks of auditing. Independent contractors then use Form 1099-NEC to calculate the amount of taxes owed to the IRS- this form helps IRS to estimate the Tax each independent contractors owe.
It’s good to mention that you need to familiarize yourself with federal and state laws as a business owner, when hiring contractors. Then, getting an excellent payment platform is half the process. A modern digital bill payment solution will ease the process of paying independent contractors. The best payment systems charge a fee based on the type of services they offer. For instance, the ability to import contractors’ payment data is excellent. You need to also remember that you need to work closely with the IRS and state tax agencies to avoid penalties. But if you follow the procedure highlighted in this article, you should be clear!