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How To Pay 1099 Contractors Correctly and Efficiently

By November 15, 2022November 16th, 2022No Comments
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There are many benefits of bringing on 1099 contractors when your business needs extra help. But knowing all the ins and outs of what is required when working with them can be complicated. If your business is looking to hire contractors for work, you’ve probably wondered how to pay 1099 contractors.

While a contractor only needs a 1099 if they live in the United States and are an American taxpayer, every country has its own rules and regulations regarding how to pay contractors.

Table of Contents:

Classifying Contractors vs. Employees

Differences between contractors and employees

When you’re hiring remote workers in the United States or abroad, it’s important to know the differences between contractors and employees. Every country has its own regulations that your business needs to follow in order to classify your workers appropriately.

In the United States, the IRS uses three criteria for determining if a worker is a contractor or an employee:

  • Relationship. The expectations of the relationship between a worker and an employer are a key way to determine whether someone is a contractor or an employee. If the relationship is temporary and based on the completion of a project, the worker is probably a contractor. However, if the worker is offered and there is an open-ended expectation that the worker will continue their employment indefinitely, they are probably an employee. If the work being done is a vital part of the business, (a law firm hiring a lawyer, for example) that points to the hired person being an employee.
  • Behavioral. Whether or not the business controls or has the right to control how the worker does their work can change the way they should be classified. If a business is more likely to tell the worker how and when to do their work, that’s probably an employee.
  • Financial. If the business has control of the economic aspects of the worker’s job, including the method and frequency of pay and unreimbursed expenses, it could impact classification.

There are several differences in the way payment and taxes are handled when dealing with contractors and employees. Generally, you won’t have to withhold a contractor’s taxes, as they are self-employed and therefore responsible for paying their own income taxes. You also don’t have to pay unemployment taxes for contractors.

You may find that many of the regulations concerning a worker’s status are a bit amorphous. If you aren’t sure whether someone should be an employee or a contractor, think about how frequently you will need their expertise. If you only need someone temporarily or seasonally, a contractor is probably the best bet. But if you need someone who can work all the time because their knowledge and skills are vital to your business, you may want to hire them as an employee.

Establish Rates and Pay Frequency

The first step to take when you hire a contractor is to decide how much and when they’ll be paid. Unlike employees, you don’t have to pay a contractor by the hour or at regular intervals. Because the nature of their work is usually based around a project, you can opt to pay them when the project has been completed or when certain milestones have been met.

You can also go the other direction when paying a contractor and pay them at the end of each day or week. If you aren’t sure when the contractor’s work will be completed (or if there is uncertainty about the amount of work you’ll have available for them), this might be a good option.

If you have a contractor on retainer, paying them quarterly is relatively common, but if they are also paid per project, make sure to establish how they’ll be paid before assigning a project to them.

How To Calculate 1099 Pay to Contractors

How to calculate pay for 1099 contractors.

The best way to determine what you owe a contractor is to have them send you an invoice when the work is completed or they hit agreed-upon milestones.

Double-check that the proper milestones have been met, then figure out how much to pay them.

  • If a contractor is being paid by the hour, multiply the number of reported hours by the rate you established in your contract with them.
    • You do not need to withhold taxes. This is the responsibility of the contractor.
  • If a contractor is on retainer, they can be paid a set fee per period and additional money for added projects, or a larger fee for periods that include additional projects.

Complete Paperwork

Every country has different regulations about the required paperwork for contractors. It’s important to know what is required for the country where your contractor lives in order to avoid penalties and legal difficulties. If your business is based in the U.S. and a contractor you hired is in a different country, there may be paperwork that the business needs to fill out for the contractor. Every country is different, so having access to local contracts vetted by experts is helpful.

In the United States, a U.S.-based contractor who pays their taxes in the United States has to fill out a W-9 for the entity paying them. The W-9 provides the employer with the contractor’s legal name and their Taxpayer Identification Number (TIN). Keep a contractor’s W-9 on file for at least four years in case of worker or IRS questions.

Process the Contractor’s Payment

Using a payroll system, pay contractors as agreed upon in the contract. Direct deposit reduces the extra costs of payroll and pays the contractor faster, but it’s up to you and the contractor to decide.

If you’re paying international contractors, you can use SWIFT (the international bank transfer system), an international money order, an online money transfer service or a contractor payments platform.

Fill Out and Submit Form 1099-NEC

For every contractor you pay more than $600 per year, you need to fill out and submit Form 1099-NEC to the IRS and contractor. The 1099-NEC (Nonemployee Compensation) reports a contractor’s earnings to the IRS. You’re also required to send a copy to the contractor before January 31. This lets the contractor file their own taxes as required by law.

If you’ve paid a contractor who is working and paying taxes somewhere other than the United States, your company may need to fill out Form 1042-S, which withholds some of the contractor’s income. When you hire foreign workers, you might need the contractor to fill out Form W-8BEN to certify that they aren’t a U.S. taxpayer.

FAQs About Paying 1099 Contractors

Below are answers to some of the most common questions people have about how to pay a contractor.

Do Non-American Contractors Need a 1099?

No. 1099 forms are for American contractors who pay taxes in the U.S. If you’re an American business that hires foreign contractors, you need to have them fill out Form W-8BEN as proof that they aren’t an American taxpayer.

Is a Contractor Classified as a Payroll Expense?

No. Contractor pay is typically classified as a business expense.

Is it Allowed To Pay a Contractor by the Hour?

Yes, but you cannot make demands on when the contractor works. You can, however, set a limit on the number of hours they will be paid for.

Is My Company Allowed To Pay a Contractor a Salary?

No. A salary is a pay structure used for employees to compensate them for the consistent work they do as a vital part of your business.

Can I Classify My Employees as Contractors?

No. It is illegal to misclassify employees as contractors. Your business could face penalties imposed by the IRS and other government agencies. Plus, if overtime was not correctly paid out, you could be responsible for paying any unpaid work.

Are There Limits to How Much a Contractor Can Work?

Kind of. Because contractors can’t qualify for overtime, the number of hours (and deadlines) needs to be set in the contract. The contractor’s pay can be an hourly amount with a set number of hours or a lump sum based on their bid. The contract should also include any deadline requirements. The contractor can decide on their own how and when to complete the work within those parameters.

How Much Tax Do I Pay For 1099 Contractors?

You don’t. It is a self-employed contractor’s responsibility to handle their own taxes.

How To Make Paying Your Contractors Easy

Paying contractors can be difficult, but it doesn’t have to be as complicated as you might think. Velocity Global’s Contractor Payments solution removes the headaches of paying contractors in the U.S. and abroad. It makes onboarding easy, provides you with a single place for document storage, allows you to make secure payments to contractors quickly, and features localized contract templates vetted by experts.

Get in touch to start paying your contractors with Velocity Global.