How to Pay an Independent Contractor: Clear Guide

The use of independent contractors is booming across most industries, with 38% of the US workforce freelancing last year.¹ Businesses are using independent contractors to gain access to personalized skills and achieve more project-based flexibility.

Having a solid payment system in place ensures smooth working relationships and can help avoid tax issues. Let’s look at how to pay an independent contractor, also known as a freelancer or 1099 worker:

How to Pay an Independent Contractor? First Steps

Before you send payment to your contractors or freelancers, you’ll want to get a few things in order first:

Establish a Contract with Your Independent Contractor

Before any work begins, you’ll want to be clear on expectations and the scope of work you need. This means having a clear and concise contract.

A well-defined contract acts as a roadmap for the project, outlining key details to avoid confusion or disagreements later. Here are some key things to include:

• Project scope: Clearly define the deliverables, including specific tasks, milestones, and the final product or service.

• Payment terms: Specify the fee structure (hourly rate, project fee, etc.), payment schedule (upon completion, milestones, etc.), and your preferred payment method (Wise for international payments can be a great option here!).

• Deadlines: Establish clear deadlines for project phases or the entire project.

• Revisions: Outline the number of revisions, edits, or updates included in the agreed-upon fee and any additional costs for further edits.

By taking the time to establish a clear contract upfront, you can set the stage for a successful and productive collaboration with your independent contractor.

💡 Use a freelance contract template like this free sample independent contractor agreement to get you started. Remember, you can always customize this template to fit the specific needs of your project.

Determine Payment Rates for Your Independent Contractor

Next, you’ll need to set a payment rate for your contractor. You’ll want to negotiate fair payment rates based on factors like industry standards, ‌project complexity and duration.

When setting an independent contractor rate:

1. Determine the payment structure: Unlike salaried employees, contractors are paid by the project or by the hour. Discuss and agree on the preferred payment structure with the contractor before work begins.

2. Research market rates: Gather information on typical rates for similar projects or tasks in your area. Resources like previous hires, online freelance platforms, and industry associations can be helpful.

3. Negotiate using research and quotes: Use your research and the contractor's quotes as a starting point for negotiations. Be prepared to justify your proposed rate and aim for a mutually beneficial agreement.

Then, when setting the payment structure you can choose various options like hourly or per-project.

Methods of Paying Independent Contractors

When it comes to actually paying your independent contractors, you have various options here as well:

Direct Bank Transfers

Direct bank transfers are secure and efficient ways to pay your independent contractors electronically, such as online bill pay with your bank. You’ll need to collect your contractor’s bank information like account and routing numbers.

Payment Services

Several options go beyond traditional direct bank transfers and can be cheaper and faster. Here are some popular payment services you can use:

• Online payment services: Platforms like PayPal and Venmo offer a convenient way to send and receive payments electronically. They're widely used and often come with user-friendly interfaces. However, these services may charge fees for transactions, especially for international payments.

• Contractor payroll platforms: Specialized payroll services designed for independent contractors often handle tax calculations and filings. Yet, you’ll want to consider factors like platform fees and ease of use.

• Wise Business: For a smart and cost-effective way to pay independent contractors abroad, consider Wise Business. This service offers international money transfers with the mid-market exchange rate and no hidden fees. Wise Business makes it easier to manage global contractor payments without hidden costs.

The best way to pay an independent contractor depends on several factors. Consider the volume of transactions, the location of your contractors, and your budget for processing fees. If you work with a high number of contractors or frequently pay internationally, a contractor payroll platform or Wise Business could be a cost-effective solution.

Checks

Checks are still a common method for paying independent contractors. While knowing how to write a check is a familiar process, there are some measures businesses should consider to improve security and prevent fraud:

• Double-check payee information: Ensure the name, routing number, and account number you have for the contractor are accurate.

• Use pre-printed checks: Pre-printed checks are more difficult to alter than blank checks.

• Consider certified checks: For larger payments, a certified check guarantees the funds are available and reduces the risk of fraud.

While checks offer a familiar way to pay contractors, electronic payment methods may be a more secure and efficient alternative.

Can I Pay an Independent Contractor With a Credit Card?

Yes, you can pay an independent contractor with a credit card, but there are a few things to consider. For example, there are potential fees that the payment processor or service may charge. Also, note credit cards may not be universally accepted.

The good news is you generally don't need to issue a 1099-NEC or 1099-MISC form for payments made by credit card. The credit card company will report these payments to the IRS via a 1099-K form.²

While credit cards offer convenience and security, they are not a practical option for everyone.

Reporting and Tax Obligations

Once you start making payments to your contractors and freelancers, you’ll have various reporting and tax obligations you’ll need to meet:

Handling Form 1099-NEC

When you hire independent contractors, you need to report their earnings to the IRS. You'll use Form 1099-NEC (Nonemployee Compensation) to do this.³

Here's what you need to know about filing a 1099-NEC for independent contractors:

• The threshold for filing: You generally need to file a 1099-NEC for each independent contractor you pay $600 or more during the tax year for services. There's also a filing requirement if you withheld federal income tax from their compensation, regardless of the amount.

• How to fill out: Form 1099-NEC reports the total amount of nonemployee compensation you paid the contractor in Box 1. You'll also include your business information and the contractor's tax identification number (TIN).

• Deadlines: The deadline to file Form 1099-NEC with the IRS is January 31st. You must also furnish a copy to the independent contractor by the same deadline.

Note the IRS may impose penalties for late filing of Form 1099-NEC. These penalties can be significant, so it's important to file on time.

Understanding Tax Deductions

The payments you make to independent contractors are tax-deductible for businesses. This includes contractor fees, plus any reimbursable expenses you agreed to cover beforehand, such as travel or materials.

However, only ordinary and necessary expenses are deductible. This means the expense must be common or accepted in your industry, and be appropriate and appropriate for running your business.

When deducting your contractor fees, keep good records. The IRS may ask you to verify your deductions, so it's important to maintain documentation, including invoices, contracts, and receipts for any reimbursable expenses.

Examples of common tax-deductible payments to independent contractors include freelance writing, web development, consulting, and marketing fees.

Is It Necessary to Withhold Taxes When Paying an Independent Contractor?

No, you do not need to withhold taxes when you pay an independent contractor or freelancer. You are responsible for sending them a 1099-NEC if you paid them over $600 so they can report and pay their taxes. Independent contractors are responsible for paying taxes on their earnings. This typically involves self-employment taxes, which cover Social Security and Medicare.

Common Mistakes to Avoid

Hiring independent contractors can be a great way to access specialized skills without the overhead of full-time employees. However, navigating the payment process can get tricky. Here are some common mistakes to avoid:

• Misclassifying employees: An independent contractor is self-employed, sets their own hours, and uses their tools and equipment. They are responsible for their own taxes and benefits. Misclassifications can lead to penalties and fines.

• Failing to Keep Proper Records: It's important to maintain clear records of your payments to independent contractors. This includes contracts, detailed records of invoices, payments made, and any relevant tax forms.

• Forgetting foreign exchange: When dealing with international contractors, currency fluctuations and international transaction fees can eat into your budget. Wise can help, with transparent fees and competitive exchange rates, you can ensure your contractors receive the full amount you intended.

Legal Considerations

There are some legal considerations to keep in mind when paying independent contractors. Generally, you need to adhere to state-specific and international laws.

While federal guidelines exist, there are state-specific laws where states have additional regulations regarding independent contractors. It's always best to check your state's labor laws to ensure you're following the proper procedures.

There are also international laws where, if you're working with an international contractor, additional tax regulations and currency exchange considerations may apply.

Best Practices for Paying Independent Contractors

Building a strong network of independent contractors is necessary for many businesses. Ensuring a smooth and efficient payment process can help keep them productive. Here are some best practices to foster positive relationships and streamline payments:

• Use clear communication and agreements: Before work begins, clearly define payment terms in a written contract or agreement. This should include the payment rate, frequency (hourly, per project, etc.), and milestones for payment triggers.

• Have an efficient payment system: Consider using online payment platforms to automate contractor payments. This saves time and reduces errors compared to manual processes. Offer convenient options that are generally faster and more secure than checks.

• Make timely payments: Abide by the agreed-upon payment schedule to strengthen contractor relationships. Late payments can damage trust and disrupt the contractor's workflow.

• Keep clear and accurate records: Keep a record of all payments made to each contractor, including the date, amount, and purpose of the payment. This is crucial for tax reporting and potential audits.

By following these best practices, you can streamline the payment process for independent contractors, ensuring timely payments and fostering a strong working relationship that benefits both of you.

What Should I Do if an Independent Contractor Requests Early Payment?

If an independent contractor requests an early payment, start by having a polite conversation with the contractor to understand the reason for the early payment request. Ask them why they need early payment. Understanding their situation can help you decide how to proceed.

Then consider your options, such as partial payment or milestone payment to demonstrate goodwill or expedite your payment process. If early payment isn't feasible, let them know as soon as possible.

Regardless of your decision, keep communication transparent. Thank the contractor for their understanding and reiterate your commitment to on-time payments.

How Often Should I Pay an Independent Contractor?

The frequency of payments to independent contractors hinges on the terms you establish in your contract. This is generally either hourly or per project. Note that some contractors may require a retainer, which is an upfront payment for work they’ll complete.

Discover Wise Business: The Easy Way to Pay Independent Contractors

Wise understands the importance of efficient and cost-effective payments for your independent workforce. That's why Wise Business offers a suite of features designed to streamline the process, including integrated accounting, multi-currency management, and batch payments—all with no hidden fees and a transparent pricing structure.

Wise is not a bank, but a Money Services Business (MSB) provider and a smart alternative to banks. By choosing Wise Business, you can focus on building strong partnerships with your independent contractors, while Wise handles the complexities of international payments.

Let Wise Business empower you to pay your independent contractors quickly, easily, and cost-effectively.

Get started today 🚀

💡 Now you know how to navigate the key steps for paying independent contractors to ensure smooth and compliant payments. Remember, following these practices goes beyond just following the rules. It fosters trust and strengthens your professional relationships with the talented individuals you rely on.

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Sources:

1. Upwork - Freelance Forward 2023
2. IRS - Understanding Your Form 1099-K
3. IRS - About Form 1099-NEC