How Do I Pay an Independent Contractor?

Payment Options and Withholding Requirements

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Paying an independent contractor is different from paying an employee, and the good news is. First, a review of how independent contractors differ from employees, then some options for paying these independent business people. 

What is an Independent Contractor? 

An independent contractor is an independent business owner who does work for a company on a contract basis. An independent contractor is not an employee and is not under the direct control of the company. The IRS has several ways to distinguish a worker as an independent contractor or employee, based on the amount of control over the work and the time of the worker. The type of work being done also has an effect on whether the worker is an employee or independent contractor; for example, a salesperson might be either. The IRS looks at the general categories of behavioral control, financial control, and the nature of the relationship. 

Basically, anyone who does work for your business who is not an employee could be considered an independent contractor. You may or may not have a written contract with this person or company. 

It's important to note that the IRS assumes that a worker is an employee unless you can prove that this person is not an employee. Before you consider paying a worker as an independent contractor, be sure you have correctly classified this worker as an independent contractor. If the IRS or state agencies audit your business and finds that the worker is really a contractor, your business may be subject to fines and penalties.

Before You Hire Your First Independent Contractor

Before you begin paying an independent contractor, you will need several documents:

An Employer ID Number (EIN), which is similar to a Social Security Number for a business, and it's required for most businesses even if you have no employees. You can apply for and get an EIN number online through the IRS.

After the new contract worker has been hired and before you begin paying this person, you must have Form W-9 (Request for Taxpayer Identification Number and Certification) signed by the worker. This form identifies the contractor (with a taxpayer identification number) and provides other information necessary for completing the payments and submitting them to the IRS.

Options for Paying an Independent Contractor

Now that you have determined that the person you want to hire is an independent contractor, you will need to An independent contractor receives compensation in one of several methods, depending on the agreement set up between your company and the contractor:

  • Hourly. Some contractors get paid on an hourly basis; for example, a computer programmer might get paid for hours worked on programming tasks.
  • By the Job. The other payment alternative is to pay for the work done or by the job. For example, a blogger might get paid by the number of blog posts created. A cleaning service might get paid a set amount for cleaning your office.

In either case, the contract determines the pay rate. A verbal contract is just as good as a written contract, but it's always better to get the details of the pay in writing, to avoid miscommunication. 

Including Additional Terms in a Payment Agreement

In addition to describing the pay type and amount, some other important terms should be included: 

  • How often is payment due? 
  • What are the "measureables" or milestones for payment? For example, a "by the job" pay agreement often includes specific deadlines for parts of the project. When the deadline is met, a specific amount of pay is released. 
  • What if the work isn't done on time? 
  • What if payments are not made on time? 
  • What if the work isn't acceptable

These payment terms are just as important as the payment amount, and they should be decided before the person begins work. 

Withholding and Deductions from Contractor Pay

In most cases, no federal or state income tax is withheld from the pay of an independent contractor. The contractor is responsible for paying his or her own income taxes and self-employment taxes (Social Security and Medicare).

Withholding under Backup Withholding Regulations

As mentioned above, you need a W-9 form for the independent contractor before work begins. In some cases, the taxpayer ID on that form may be incorrect or missing. In those cases, you may have to withhold federal income tax from that person's payments. This is called backup withholding.

You must withhold federal taxes at the backup withholding rate of 28%. Just as with an employee, take the gross pay of the person and multiply it by .28 to get the tax. 

Reporting and Paying Backup Withholding to the IRS 

If you must withhold taxes from an independent contractor, you must also pay these taxes to the IRS at regular intervals. Backup withholding must be reported to the IRS on Form 945, Annual Return of Withheld Federal Income Tax. Form 945 is due January 31, for the previous tax year.