Gig workers, freelancers, and consultants are skilled, specialized, and ready to work. And they’re just the growing workforce you need. Learn the obstacles of 1099 contractor engagements, how to manage a payroll system for contractors, and lean into the gig economy with confidence.
Your business is off and running and you know that you need to improve traffic flow and overall aesthetic to your website, but you also know that hiring a full-time web designer is just not in the cards. This, and many other short-term projects, are great opportunities to hire an independent contractor. These individuals specialize in specific task loads—building their own small businesses that align with their skill sets and business model—so that you can focus on your customers and growing your base. Familiarizing yourself with the solutions to common deterrents to hiring a 1099 contractor will lead to successful vendor engagement.
What makes paying 1099 contractors such a pain
While embracing the gig economy provides much-needed solutions without enrolling additional staff, the differences in how independent contractors are compensated—and the tax requirements as a result—can feel perplexing. Your business is essentially paying another business (B2B payments), so the process gets a little tricky. For some, these obstacles become pain points that lead hiring companies away from engaging freelancers.
Manual payments
Because 1099 contractors are not on the payroll, “paying” them is more akin to paying an electric bill than compensating a person on staff. For each contractor that you hire for individualized projects or tasks is an invoice—or multiple invoices—that needs to be reviewed, approved, and processed. These additional steps can become cumbersome and lead to poor tracking practices, leaving both the hiring company and the contractor in conflict.
Inconsistent payment schedules
Employee paychecks are on a set schedule, typically twice a month. Most companies batch process payroll for all employees, in all departments. This kind of scheduled payment is reliable and consistent—it can be anticipated and planned for. Working with various contractors, however, results in myriad invoices coming into the company in different cycles.
Manually sending Form 1099
Businesses that pay independent contractors more than $600 over the course of a year must provide the contractor with form 1099-NEC come tax season. Much like the W-2 that is generated for an employee, the 1099 summarizes the financial exchange between a hiring business and the contractor. But the difference is that the contractor uses that form to determine their own taxes.
With a small roster of independent contractors, providing a 1099 isn’t that daunting of a task. But where a business chooses to work with multiple contractors, involving multiple invoices over the course of a year, manual creation of this documentation is riddled with potential error points.
Tax penalties for errors
Mismanaging the financial relationship with an independent contractor can result in late fees and other penalties during tax season. Hiring businesses must provide a 1099-NEC to independent contractors no later than January 31st. The late fees and penalties range from $50-$500+ for each 1099 that is incorrect or late.
One of the most common errors found when working with a 1099 contractor is an incorrect Taxpayer Identification Number (TIN) on their W-9 form, often just a social security number (SSN) if the person is operating as a sole proprietor. Hiring companies must verify these numbers are accurate or face consequences that may include the IRS requiring backup withholding, or the withholding of a percentage of invoice payments.
Benefits of paying independent contractors through a payroll system
The impact of Covid-19 on the global economy is tangible throughout the business landscape. In an independent study published in the fall of 2020, it was determined that 98% of those who had started freelancing during the pandemic were likely to continue freelancing in the future. Hiring businesses will need to learn how to overcome potential pain points in the relationship. One option is to treat payments made to contractors as if they were on payroll, creating a consistent system and reliable data management to minimize the seemingly sporadic nature of those AP cycles.
Quick payments
Getting contractors paid in a timely manner benefits both parties: Contractors are reliant on payments for their own cash flow needs and your business builds report within a community of skilled workers. Having contractors enrolled in a payroll system means that vetting invoices for approval and processing exists in a structured timeline, strengthening the efficacy of AP cycles.
Accurate payroll records & audit logs
When contractor payments are processed manually, human error and workload can result in inconsistent and inaccurate data entry. Leaning into a payroll system for contractor payments minimizes, even eliminates, inaccuracies. Further, a digitized payroll system for contractor payments means audit logs that track dates, times, processing windows—all elements for communication should questions or concerns arise.
Auto-generate Forms 1099-NEC and 1099-MISC
Having a payroll system in place for paying contractors means no penalties come tax season. Form 1099-MISC and 1099-NEC can be created with accurate information and sent to contractors before deadlines lapse. This means no back and forth with the IRS, no corrections, and no fees.
In-depth reporting
Having the right contractor on the right project at the right time can be the difference in balancing a budget and achieving productive outcomes. When contractors are included in a payroll system, their data can be compared in real time against other contractors that offer similar services, setting up your procurement team with a strategic advantage.
How to pay 1099 contractors
In many ways, paying independent contractors is easier than paying regular employees. A hiring business works closely with an independent contractor while negotiating a contract to determine payment terms: an agreeable hourly or project rate and payment frequency. From there, the contractor submits invoices in alignment with the pay frequency. At the end of the year, the hiring company provides a 1099-NEC that summarizes the total amount they have been paid. Then, each contractor files their own self-employment taxes that include social security tax and medicare taxes. They also have the ability to submit deductions for business expenses.
To pay a 1099 contractor:
1. Collect form W-9
Before the first invoice is ever received, if the contractor has not already provided an up-to-date W-9 form, request one is submitted. This form includes identification information that is imperative to filing an accurate 1099.
2. Set-up the contractor in your payroll system
Using the data collected on the W-9, and any other relevant contact or contract information from the contractor, create a profile in the payroll system.
3. Determine which payment method to use
While some freelancers still prefer a physical check, many have discovered that ACH or other digital payment methods are faster and more reliable.
4. Send payment to the 1099 contractor
Payment amounts are made to contractors based on invoices submitted that summarize projects or hours worked.
5. Send Form 1099-NEC
The 1099-NEC forms must both be sent to each independent contractor as well as filed with the IRS by January 31st.
To learn more about the above steps in depth, check out our previous blog post on how to pay your contractors and freelancers. For paying international contractors and freelancers, check out our post here.
Why Routable is the best way to pay 1099 contractors
1. Direct deposit for contractors
Small business owners enjoy the confidence—and assurance—that once their invoice has been approved, they will see their payment directly in their account.
2. Easy ACH payments
Fast, reliable ACH payments means contractors submit one-time, secure, encrypted bank account information without having to share sensitive documentation over email. Payments are processed quickly and efficiently throughout the lifecycle of the relationship.
3. Mass payouts to save time
Paying multiple freelancers and gig workers at once can be time consuming. With CSV uploads, Routable processes hundreds of payments at once while identifying duplicates or potential errors.
4. Automated payments
Live the benefit of increased team productivity with 70% reduction in tedious, manual labor through automation.
FAQs
Still not sure if jumping on the gig economy bandwagon is the right choice? Here are some common questions businesses new to hiring contractors ask:
Are independent contractors considered a payroll expense?
No. Businesses that pay independent contractors do not have to pay employment taxes like unemployment, workers’ compensation, or Federal Insurance Contribution Act (FICA) for those workers. Further, hiring companies do not have to provide benefits like vacation time, pension plans, or deduct state or federal income taxes for independent contractors.
Can you pay an independent contractor hourly?
Yes. However, while a contract with an independent contractor may have an hourly rate, the hiring business generally does not have a say in when the independent contractor may work. Whereas employees have set hours and schedules, freelancers work on their own time, setting their pace and timelines. With that said, it is always in the best interest of the contractor to work with the hiring business on what hours best match the needs of the project.
Can an independent contractor be paid a salary?
No, not really. While a contract with an independent contractor may be based on project rate or retainer that covers an agreed number of hours—similar to how a salary is structured—the payment would not be considered a salary or a wage. Payment would still be made through invoicing and classified as a vendor.
Is it illegal to treat an employee as an independent contractor?
Yes. W-2 employees are entitled to minimum wage, overtime, and benefits from their employer. Independent contractors are not entitled to these considerations, and maintain autonomy from the hiring company. Department of Labor (DOL) worker classification—employee v. independent contractor—depends on how the worker is compensated, the level of oversight a hiring company has on their work, and how integral the work they perform is to the primary function of the hiring company.
How many hours can an independent contractor work?
The number of hours an independent contractor works is determined by the contract or agreement in place with the hiring company. Contractors are not guaranteed overtime pay, though they may request a provision in their contract that highlights times when a higher hourly rate is billed. Any rate fluctuations should be well understood between both parties during the on-boarding process.
Conclusion
The gig economy is growing: Studies estimate 87 million gig workers in the US by 2027. Not everyone is ready to embrace 1099 contractors, but the workforce is changing. Establishing a payroll system to pay gig workers transitions your business from fearing IRS penalties and fees to embracing a skilled labor force ready to bring the very best of what they have to offer to your business.