Hiring and Paying an Independent Contractor
Taxes, Contractor Agreements, Backup Withholding
Many small business owners prefer to work with independent contractors rather than hiring employees. Benefits of hiring independent contractors include:
- Flexibility in being able to vary hours worked, or paying by project, and not having to pay when work isn't available.
- Outsourcing non-essential tasks, like IT and maintenance, so you don't have to set up a new department within your company.
- Being able to terminate the relationship easily without the paperwork and potential problems that go with firing an employee.
- Not having to pay FICA taxes (Social Security and Medicare) in terms of taxes, benefits, and agreements. But you must still have a contract (not an employment contract), and there is still paperwork you must complete and taxes that must be allocated.
- Less hiring paperwork, fewer reports, and payments to the IRS.
As the hiring employer, there are still some things you must do to hire and start paying that independent contractor.
An independent contractor is an individual who does work for another individual or company. Independent contractors are business owners who are in a trade, business, or profession and who offer their services to the general public. Someone is an independent contractor if the person paying them can control or direct only the result of the work. The hiring party can't tell the independent contractor what to do or how it will be done.
A perfect example of an independent contractor is a cleaning service. The service comes into your office to do work, but the cleaning service workers are not employees of your company. You can tell them which offices to clean and when you want them to clean, but you can't tell them what cleaning supplies to use or how to run the vacuum cleaner.
Independent contractors are considered to be business owners. They report income on their personal tax returns, and they can deduct business expenses.
For various reasons (mostly to do with payroll taxes), the IRS is concerned that workers are appropriately classified as either independent contractors or employees. The IRS considers that worker to be an employee unless you can prove otherwise.
The IRS determines the status of workers on a case-by-case basis, and it looks at several factors - including behavioral, financial, and control - to determine status. If you are unclear about the status of people who work for your business, you can request a determination from the IRS.
Mis-classification of a new worker as an independent contractor can create tax liabilities, fines, and penalties for your business, so be sure that the worker you are hiring is an independent contractor, not an employee.
The most important document you must get from an independent contractor is Form W-9. This form must be completed and signed by all independent contractors when they begin work for your business. The person is required to provide a tax ID number (social security number, employer ID (EIN), .
The W-9 form serves the same purpose as a W-4 form for newly-hired employees.
If an independent contractor doesn't have a tax ID number on file or if the number is incorrect, they may be subject to withholding from their payments (called backup withholding – see below).
You may be able to check taxpayer IDs with the IRS by registering to use their e-Services process.
In addition to the W-9 form you'll need specific he new hire paperwork for each independent contractor you hire:
- The person's resume or professional qualifications, for your own protection and to verify in case of an audit, and
- a copy of the contract. Even the most simple IC relationship should have a contract.
In the same manner, as you check references for an employee, be sure you check the credentials of a contractor before hire.
You can do a background check on all prospective contractors, in the same way, you check before you hire employees. For example, if you are considering hiring a bookkeeping service, make sure this person has no felony convictions.
Some jobs require background checks. For example, state laws require background checks for anyone working with children, the elderly, or disabled people.
If the independent contractor is organized as a business, you should do a check with the Better Business Bureau to make sure no complaints have been filed against this business.
Don't forget the tried-and-true web search, including reviews of the business.
Paying an independent contractor is pretty simple. You can pay by the hour or by the job. In most situations, you don't have to withhold income taxes from independent contractor income. You don't have to pay unemployment taxes on independent contractors.
Independent contractors are responsible for paying their own income taxes and self-employment taxes (for Social Security/Medicare).
You must keep track of payments you make to independent contractors each year and report the total payments to the IRS.
For each independent contractor you paid $600 or more during the year, you must report the total amount paid on Form 1099-NEC, beginning with the 2020 tax year. (Before 2020, you would have reported this income on Form 1099-MISC, which is now being used for other types of income.)
You must send the 1099-NEC form:
- To each independent contractor no later than January 31 of the following year, and
- To the IRS no later than January 31, using either mail or electronic filing.
The exact date changes each year, depending on holidays and weekends. See this article with a business tax calendar for the due date for the current year.
In most circumstances, you do not need to withhold income taxes from the payments you make to independent contractors. But there are some exceptions:
You as a business owner and payer must withhold taxes on payments to an independent contractor if you receive a backup withholding notice from the IRS. Usually the IRS will send this notice if the taxpayer identification number (Social Security Number, Employer ID Number, or Individual Taxpayer ID Number) of the independent contractor is incorrect or missing.
You don't have to do anything until you receive the backup withholding notice from the IRS. Then follow the specific instructions on the notice and begin withholding income taxes from the independent contractor immediately at the backup withholding rate of 24%.
Each year you'll need to send the IRS a report on the amounts you have withheld from each independent contractor, using IRS Form 945.
In every case, before you hire an independent contractor, create an agreement and get it signed by the contractor. The agreement should include details about the requirements of the contractor, pay rates, and sections about non-disclosure and confidentiality.