Top Considerations when Paying Independent Contractors

An independent contractor refers to an individual who does work for but is independent of an organization.

17:53 26 August 2021

An independent contractor refers to an individual who does work for but is independent of, an organization. Essentially, they would be a non-employee. 

 

Independent contractors also call themselves ‘freelancers’. 

 

Paying independent contractors can be tricky to navigate since it differs from the process of paying employees. 

 

We break down all the considerations you need to make when paying your independent contractor including contracts and forms, and the all-important 1099-NEC vs 1099-MiSC.

 

Ensure they are not an employee

The first and most important thing to do is ensure that you are paying the independent contractor correctly for their position. 

 

It is imperative to classify whether the worker is an employee or an independent contractor. If not stated, the IRS is likely to assume they are an employee as a default, which can lead to issues with tax. 

 

Make sure that the person hired is meant to be an independent contractor instead of an employee. If there is any uncertainty, it is best to request the IRS to determine it for you. Get it wrong, and you might be subject to hefty fines or penalties. 

 

Contracts

As you would with any employee, ensure you draw up a contract stating rates, contractor objectives or requirements, confidentiality clauses, and anything else relevant to your agreement.

 

Form W-9 

Before an independent contractor starts their work for you, they need to fill out and submit FORM W-9.

 

The form requires a tax ID number and social security number. It is equivalent to the W-4 form that is required from employees when first hired. 

 

If a contractor does not have a required tax ID number, there may be a withholding of payments until they get one. Taxpayers' IDs can be checked by the employer using the IRS e-Services process. 

 

Payment plans

How you wish to pay your independent contractor depends on the type of job they perform, and your preference. You can pay hourly, weekly, monthly, or on a job-by-job basis. 

 

Keep transfer fees in mind, and try to limit this. If you can pay once-off for a job or assignment, rather than splitting it into several monthly payments, you are likely to save those extra costs for yourself. 

 

You are not required to handle income tax, or any other form of medical or social security tax, from the contractor’s income (unless instructed by the IRS - more on that later). They are responsible for handling and paying their own taxes.

 

Tax Reporting

 

Stay organized, and keep a record of all payments made to your independent contractors. Each year, you will be required to declare these payments to the IRS. 

 

As of the start of the 2020 tax year, employers must declare the total amount paid for each independent contractor that received $600 or above. This should be done using Form 1099-NEC. 

 

You must send the form to the relevant independent contractors and the IRS by the required date, which changes each year.

 

If you’re wondering what the difference is between 1099-NEC vs 1099-MiSC: Form 1099-NEC is in place for payments to non-employees since the start of 2020, replacing Form 1099-MiSC. 

 

Backup Withholding

As we mentioned previously, it is generally not necessary to calculate and withhold income tax from independent contractors’ payments. However, if the IRS sends you a backup withholding notice, you are required to follow this. 

 

This is usually done when the independent contractor does not have a taxpayer ID number. If you receive a notice, follow the instructions given by the IRS and begin with withholding the income taxes with immediate effect. The backup withholding rate is 24%.

 

You will need to report any amounts withheld from independent contractors to the IRS every year using Form 945. 

 

Contractor working abroad 

If you have hired an independent contractor operating out of another country, you will need to consider the exchange rates. 

 

Extra fees will be added when paying the contractor, and these will vary according to the method. Explore your options before making a decision, to avoid unnecessary costs. 

 

You also need to consider the security risks involved with international transfers: ensure you are following all safety measures recommended by your financial services.