How to pay contractors: A guide for small businesses

Note: This article is for business owners in the United States.

Maybe your business has a huge project in the works and you could use a little extra help, or maybe you’re looking to bolster your team to prepare for an upcoming busy season. For a business with varying, seasonal, or flexible needs, hiring full- or even part-time employees isn’t always the best option. 

If that’s you, working with independent contractors may be a better (and cheaper!) choice. An “independent contractor” (or just “contractor”) refers to a self-employed person who provides work or services for another individual or business. They are under a contract, and are not considered traditional “employees,” which means how you pay a contractor is different from how you pay an employee. 

Whether you’ve already worked with a contractor or are just weighing your options, we’re here to teach you about the six ways small businesses pay contractors, what to consider when paying contractors, and how to hire contractors. We’ll also provide you with the right info to navigate the complexities of taxes and contractor forms. Let’s get into it!

What is an independent contractor?

An independent contractor is a self-employed person who provides work or services for another individual or business, under a contract. 

Contractors go by many names (confusingly enough)—they sometimes refer to themselves as:

• Freelancers
• Consultants
• Entrepreneurs
• Business owners
• Self-employed individuals

Independent contractors vs. employees

At first, independent contractors may not seem that different from employees, since they help your business complete certain predefined tasks and, in exchange, you pay them an agreed upon amount for their work. But don’t be fooled—they’re not the same! 

The key difference comes down to how much control you have over how and when the work is done; this distinction is really important for tax and payroll reasons. According to the Internal Revenue Service (IRS), someone is an independent contractor “if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”

So if you tell a worker they need to work from your office during a specified period of time, the IRS is likely to recognize them as an employee. An employee works for you while a contractor does work for you.

Contractors are often used when the work you need done is project-based—for example, when you need a particular task done and that’s all. Employees, on the other hand, tend to be responsible for different tasks that are ongoing.

If you’re unsure whether a worker is an employee or an independent contractor, you can submit Form SS-8 to the IRS for an official designation.

Six ways small businesses pay contractors 

So, how do you pay contractors? Contractors need to be paid in a timely and professional manner (sounds reasonable), but the process can differ from contractor to contractor. The method (or methods) you use to pay your contractors will depend on your unique situation—you’ll need to consider which ways make the most sense based on how much and how often you’re paying your contractors. 

The amount of options you have will also depend on how your contractors accept payments, so keep that in mind too. For example, you might work with a contractor who only accepts checks, or a contractor who only uses online payments. 

Without further ado, let’s go over the six most common ways to pay your contractors, along with some of the pros and cons, so you can know what to expect and what your options might be when paying contractors.

Checks

If you’re younger than 35, you may have never seen a check before. Okay, maybe that’s a bit dramatic, but still—checks aren’t too common these days. However, writing personal checks and giving them to contractors is still appealing to some business owners because there’s no fancy technology needed. 

Keep in mind, mailing a check or transporting it to each contractor can get inconvenient pretty quickly, especially if you need to make regular payments. 

Plus, if you do need to mail your checks, it can take a few days to get delivered, and then a few days on top of that to get processed, which can really slow down a contractor’s cash flow. Contractors might also be reluctant to accept a check if it’s their first time working with someone, because they can’t be 100% certain it won’t bounce. All of this to say, you might encounter some contractors who aren’t the biggest fan of checks, so be prepared to pay using other options.   

Wire transfers

This is another option that isn’t super common these days. (We saved the best options for last 😉).

Wire transfers are fairly quick (domestic transfers can be processed within 24 hours), but may have hefty fees that can seriously add up for both you and your contractors. If you’re sending payments on the smaller side on a frequent basis, wire transfers might not make the most sense. 

Unlike credit card payments, it’s quite difficult to retrieve any cash you send if you encounter any issues, so make sure you trust your contractors. You don’t want to end up in a sticky situation! 

ACH transfers 

Okay, let’s get into the more ✨modern✨ options now. If both you and your contractors are in the US, ACH transfers (direct deposit payments) are convenient and secure for everyone involved, and are a great option for recurring payments. 

Your contractor might accept ACH payments via virtual terminals (an app that lets you accept online payments), point-of-sale hardware, a payment gateway on their website, or automatic invoices. 

Before you pay via ACH payments for the first time, your contractor will need to gather your name and banking information, which is often done through their payment gateway. Alternatively, your contractor might be able to give you their banking info so you can initiate the transfer.

Credit card payments

Another option from the twenty-first century: Credit card payments! Credit cards are  a convenient and secure option if your contractor happens to use a merchant service or an online payments platform (more on those later!) to collect payments. They’re quick and easy, and you and your contractor don’t have to exchange any banking info.

Credit cards are a great option to go with because of the added security. For example, if there’s a problem with your payments, credit card companies can help you dispute the charges and recover your money, which isn’t as easy if you’re paying through other methods. 

Online payments

If your contractor accepts online payments through platforms like Wave’s online payments feature or PayPal, this is another quick and convenient option to pay them. (We personally prefer Wave’s online payments feature, but we’re a little biased.) 

Most online payments platforms should give you the option to securely pay by credit card, too. For instance, Wave’s online payments feature accepts payments via Visa, Visa Debit, Mastercard, Mastercard Debit, American Express, Apple Pay, and bank deposits. 

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Payroll software

Using payroll software to make payments, record accounting entries, and file tax documents for your independent contractors can make both of your lives waaay easier.  

For example, Wave’s payroll feature supports paying both employees and independent contractors when you run payroll. You can deposit payments quickly, reliably, and directly into your contractors’ bank accounts, which means less work for you and a convenient way for your contractors to get paid (we love a win-win situation). Our payroll feature will also automatically generate year-end 1099 forms for your contractors, too (but more on why that matters later!).

What to consider when paying contractors 

Working with contractors—and paying them—can seem a bit complex at first since it is different from paying traditional employees, but we’ll help break down what to consider when paying contractors. Since contractors are self-employed, they make the rules when it comes to their pricing and working hours. As you can probably guess, this means there are different rules when it comes to taxes and hiring. 

Let’s dive into some of the most important things you’ll need to consider when paying contractors, including:

• Taxes
• Hiring
• Pricing 

Contractor payments taxes

Buckle up, we’re talkin’ taxes (say that three times fast!). Taxes are handled a little differently when it comes to contractors. While taxes are usually withheld by an employer for employees, contractors are responsible for paying their own taxes. 

Because of this, 1099-NEC forms report payments to independent contractors, while W-2 forms report payments and withholdings for employees.

…Okay, that was a lot of numbers and letters. Let’s back up a little and do a deeper dive  into contractor payments taxes and the tax forms you need to know about. 

How is a 1099 form different from a W-2 form?

Let’s go over the differences between a W-2 form and a 1099-NEC in a little more detail (they’re really not as intimidating as they sound!). One of the key payroll differences between contractors and employees comes up during tax time, when their income is reported to the IRS. When you pay an employee, you’re responsible for withholding income and FICA taxes and for reporting all wages paid and withholdings to the IRS. 

That reporting is done via IRS Form W-2, which looks something like this:

Source: IRS

When you hire an independent contractor, on the other hand, they’re responsible for paying and submitting the applicable payroll and self-employment taxes. 

Because of this, payments to contractors are reported using a different form: IRS Form 1099-NEC. 

‍You’re responsible for preparing a 1099-NEC for every contractor you’ve hired if you’ve paid them over $600 in total for the tax year. This helps contractors determine how much they owe in taxes, and helps the IRS keep track, too.

Source: IRS

Both W-2 and 1099-NEC forms must be prepared following each year and provided to both the Social Security Administration (SSA), IRS, state and local agencies, and workers.

Psst, if you use Wave’s payroll feature to make payments to contractors, the necessary 1099 forms are automatically created for you.

How to hire a contractor

Phew, we made it past the tax section! That wasn’t so bad, was it? (Don’t answer that.) Let’s get into a lighter topic now: how to hire a contractor.

Once you’ve determined you want to hire an independent contractor or freelancer, it’s time to do some research and start hiring! You can check out freelance job boards (like Freelancer.com, FlexJobs, and UpWork) and LinkedIn or do some good old fashioned Googling to find candidates.

For more specialized tasks (like writing, legal help, web design or development, etc.), we recommend asking around in your community for independent contractor referrals. Someone in your network might have worked with a freelancer they loved—and referrals are a great way to find the best contractors without all the legwork of searching through hundreds of profiles and vetting each candidate.

New hire forms and documents for contractors

Once you’ve chosen a contractor you want to work with, there are two key documents you need to hop on before work begins:

• IRS Form W-9
• A written contract

The W-9 form is filled out by the independent contractor and returned to you. It’s a formal request for key information—including their business name, address, and either social security number (SSN) or Employer Identification Number (EIN)—that you’ll need to create a 1099-NEC later on.

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Source: IRS

The second document, a written contract, sometimes gets pushed to the backburner, but is   super important when working with contractors. A solid contract eliminates confusion, defines the contractor relationship, outlines payment methods and timelines, and protects you from IRS suspicion.

The IRS considers all workers to be employees unless you provide evidence otherwise. A written contract (a nice and simple title like “Independent Contractor Agreement” is best) can serve as that evidence in the case of an audit.

Contractor pricing 

Almost done! The third thing you need to consider is contractor pricing. Independent contractors are paid for the work they produce, along with their time. That means they may charge in a few different ways:

• By the hour
• By the project
• On a retainer

Hourly pricing means you’re paying for their time, based on an hourly rate you both agree to. However long a task takes to complete, you pay for each hour. 

Project pricing is a more fixed pricing structure. You and the contractor agree to a set price for each project, and you pay for the end product—not the time it took to produce it.

Retainer pricing often applies when you have an ongoing and fairly regular relationship with a contractor. In that case, you pay a set amount (usually per month) for an agreed upon amount of time or number of projects.

How to pay contractors: Next steps

Now that you know how to work with and pay contractors, you’re ready to get out there and find some awesome contractors to help you grow your business! To recap: 

• The frequency and amount of money you’re paying independent contractors can inform the method you use to pay them. We suggest using online payments, like Wave’s payments feature, or a payroll software, like Wave’s payroll feature, to help you painlessly pay contractors and generate important forms. 
• 1099-NEC forms must be prepared following each year and provided to the SSA, IRS, state and local agencies, and your independent contractors. 
• Before you start working with a contractor, you’ll need to sort out IRS Form W-9 and a written contract. 

One last thing before we go—did you know that Wave’s payroll feature is part of our entire suite of money management tools? Our money management tools are all in one super cool place, saving you from hours of research and cobbling together a bunch of different software (who has time for that?!). From invoices to online payments and automated bookkeeping, you’ll always be on top of your money management the way you’re on top of your business.