Cloud Accounting & Finance

Pay Your Contractors the Right Way

Pay-Contractors

So you’ve decided you need another worker, but you don’t want to take on another employee. In many cases, hiring an independent contractor is a great strategy to handle these short-term jobs, but these types of workers come with unique issues to consider, such as the right way to pay your contractors. Below are some important matters to keep in mind.

How to Distinguish Independent Contractors from Employees.

Once you’ve decided to bring on an independent contractor, keep in mind that the IRS may classify them as an employee. Independent contractors have preferential treatment over employees in many ways, so employers must be careful to support their categorization. Although you must consult a professional accountant before making these decisions, the following traits generally apply only to independent contractors and not employees.

Generally, an independent contractor:

  • Works for multiple employers;
  • Doesn’t earn a salary;
  • Doesn’t receive benefits;
  • Doesn’t perform work directly related to the company’s business;
  • Works without direction; and
  • Sets their own hours;
  • Receives no training

Look good? Once you’ve determined that your worker is indeed an independent contractor, you need to decide how to deliver payment.

Hourly vs. Fixed-Payment Compensation.

Frequency of payment will be determined by the agreement you’ve made with the independent contractor, but are hourly rates or fixed-payments better? As it turns out, hourly rates generally place more risk on the employer. Without oversight of the independent contractor’s schedule, these workers may work more hours than planned and total compensation may reach higher than anticipated. Conversely, fixed-payment compensation shifts risk away from the employer and onto the independent contractor. If an independent contractor takes excessive time to complete a project, they bear the financial disadvantages of such a situation. Given these considerations, fixed-payments are generally seen as preferential for employers and may benefit you too.

Taxes and Forms.

When hiring independent contractors, there are a few tax and filing obligations that employers need to be aware of. Here are the main ones to keep in mind:

  • Filing a W-9 “Request for Taxpayer Identification Number and Certification”: This is the first form independent contractors should complete and provide you prior to being paid. It gives you, the employer, the necessary tax information on your independent contractor, which may be required in the future.
  • Taxes and Withholding: Independent contractors are self-employed and therefore manage their own tax obligations. Therefore no part of their compensation need be withheld for FICA or income tax purposes. However, in the case that your independent contractor does not have taxpayer identification, backup withholding is required at the rate of 28%.
  • Filing a form 1099 “Miscellaneous Income”: If over the course of a year, you pay your independent contractor $600 or more, you will need to file a Form 1099 by January 31 of the following year. Follow the instructions on the form to ensure you’ve submitted the correct copies to your independent contractor, the IRS, and your files. If total annual compensation is less than $600, the form 1099 is unnecessary.

As always, consult a professional accountant to answer your specific tax obligations.

Reimbursing Expenses Incurred by the Independent Contractor.

Although most expenses encountered by an independent contractor will be theirs to bear (and covered by their rates and fees), these workers may purchase incidental supplies or services that you will want to cover. Instead of having them fill out a request for expense reimbursement, Abacus can be an easy option for transferring these funds. Simply have the independent contractor open an account on Abacus, take a picture of the receipt associated with the expense, and request reimbursement. No hassle. No waiting. They can then go back to delivering their services, and you can go back to doing what you love: running your business.

Sources IRS, AboutMoney

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