Everything you need to know about paying contractors

September 3, 2020
5 minutes read

Note: This article pertains to business owners in the United States.

When it’s time to hire a little more help, most small business owners jump straight into thoughts of onboarding an employee or two. But for businesses with varying, seasonal, or flexible needs, hiring full- or even part-time employees isn’t always the best option. If that’s you, working with independent contractors may be a better choice.

Independent contractors are a popular option for businesses both large and small. Just like employees, contractors need to be paid in a timely and professional manner—but we don’t talk about them much when it comes to setting up your payroll.

Whether you’re already working with a contractor or just weighing your options, the article below will help you better understand their role, how to hire an independent contractor, and unique tips on how to pay them using Wave Payroll.

What is an independent contractor?

In practical terms, independent contractors aren’t that different from employees. They help your business complete certain predefined tasks and, in exchange, you pay them an agreed upon amount for their work.

Note: Contractors go by many names—they’re sometimes called freelancers, consultants, entrepreneurs, business owners, or self-employed individuals.

The key difference comes down to how much control you exercise over how and when the work is done—and the classification is really important for tax and payroll reasons. Defining what an independent contractor is, the Internal Revenue Service (IRS) has this to say:

“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.”

So if you tell a worker they need to work from your office during a specified period of time, the IRS is likely to recognize them as an employee. An employee works for you while a contractor does work for you.

Contractors are often used when the work you need done is project-based—when you need a particular task done and that’s all. Employees, on the other hand, tend to be responsible for myriad tasks that are varied and ongoing.

Note: If you’re unsure whether a worker is an employee or an independent contractor, you can submit Form SS-8 to the IRS for an official designation.

What’s the difference between 1099 and W-2?

TL;DR: 1099-NEC and 1099-K forms report payments to independent contractors, while W-2 forms report payments and withholdings for employees.

One of the key payroll differences between contractors and employees comes up during tax time, when their income is reported to the IRS. When you pay an employee you’re responsible for withholding income and FICA taxes and for reporting all wages paid and withholdings to the IRS. That reporting is done via IRS Form W-2, which looks something like this:

Source: IRS

When you hire an independent contractor, on the other hand, they’re responsible for paying and submitting the applicable payroll and self-employment taxes. Because of this, payments to contractors are reported using a different form: IRS Form 1099-NEC.

Source: IRS

Both W-2 and 1099-NEC forms must be prepared following each year and provided to both the Social Security Administration (SSA), IRS, state and local agencies, and workers.

Note: If you use Wave Payroll to make payments to contractors, the necessary 1099 forms are automatically created for you (more on this later!)

How to hire a contractor

Once you’ve determined you want to hire an independent contractor or freelancer, the hiring process unfolds similarly to hiring an employee. You can check out freelance job boards (like Freelancer.com, FlexJobs, and UpWork) to find candidates.

For more specialized tasks (like writing, legal help, web design or development, etc.), we recommend asking around in your community for independent contractor referrals. Chances are good someone in your network has worked with a freelancer they loved—and referrals are a great way to find the best contractors without all the legwork of searching through hundreds of profiles and vetting each candidate.

New hire forms and documents for contractors

Once you’ve chosen a contractor you want to work with, there are two key documents you need to execute before work begins:

The W-9 form is filled out by the independent contractor and returned to you. It’s a formal request for key information—including their business name, address, and either social security number (SSN) or employer identification number (EIN)—that you’ll need to create a 1099-NEC later on.

Source: IRS

The second document, a written contract, is often overlooked but incredibly important when working with contractors. A solid contract eliminates confusion, defines the contractor relationship, outlines payment methods and timelines, and protects you from IRS suspicion.

The IRS considers all workers to be employees unless you provide evidence otherwise. A written contract (titled as an “Independent Contractor Agreement” is best) can serve as that evidence in the case of an audit.

Contractor pricing and payment

Speaking of payments, independent contractors are paid for the work they produce as much as for their time. That means they may charge in a few different ways:

  • By the hour
  • By the project
  • On a retainer

Hourly pricing means you’re paying for their time, based on an hourly rate you both agree to. However long a task takes to complete, you pay for each hour. Project pricing is a more fixed pricing structure—you and the contractor agree to a set price for each project—and you pay for the end product, not the time it took to produce it.

Retainer pricing often applies when you have an ongoing and fairly regular relationship with a contractor. In that case, you pay a set amount (usually per month) for an agreed upon amount of time or number of projects.

How to pay contractors with Wave

Now that you’ve started working with contractors, you need to be able to pay them. Wave Payroll supports paying both employees and independent contractors when you run payroll. So for Wave Payroll users, it’s easy—simply add contractors into your payroll and go.

  1. Add a contractor

Navigate to Purchases > Vendors and add a new vendor. Be sure to mark the new vendor as a 1099 contractor. Indicate whether you’ll pay the contractor via direct deposit.

  1. Pay a contractor

Under Purchases > Bills, click on Create a Bill. Create the new bill as you would any other bill, specifying the quantity, price, expense category, etc.

Once created, head to the Bills page. Under Actions, select Pay contractor. If you choose to Pay by direct deposit, the bill will be automatically added to your next payroll run.

That’s it! Wave Payroll will automatically generate year-end 1099 forms for your contractors, too.

By Kiera Abbamonte

The information and tips shared on this blog are meant to be used as learning and personal development tools as you launch, run and grow your business. While a good place to start, these articles should not take the place of personalized advice from professionals. As our lawyers would say: “All content on Wave’s blog is intended for informational purposes only. It should not be considered legal or financial advice.” Additionally, Wave is the legal copyright holder of all materials on the blog, and others cannot re-use or publish it without our written consent.

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