What Every Business Should Know About Paying Contractors

Whether you’re bringing on a local freelancer or working with a web designer overseas, this guide will walk you through how to pay independent contractors correctly without breaking the bank or the law.

What Is an Independent Contractor?

Before you send that first invoice, double-check that they legally qualify as contractors, not employees in disguise. According to the IRS, independent contractors control how they perform their work, not just the end result. They typically use their own tools, work with multiple clients, and set their own hours.

Typical contractor roles include:

• Freelance graphic designers

• Content writers/bloggers

• Software developers

• Virtual assistants (VAs)

• Consultants and marketing strategists

Misclassifying employees as contractors can result in back taxes, penalties, and lawsuits. To be safe, review the IRS’s three-prong test on behavioral control, financial control, and the nature of the relationship.

Example of an Independent Contractor 

Sarah, a gift boutique owner, hires Mark, a freelance web developer, to revamp her company’s website. Mark operates from his home office, sets his hours, uses software, and submits invoices for completed milestones. This situation strongly suggests that Mark is an independent contractor.

Confirm the Legal Classification

Misclassification is among small business owners’ most costly mistakes when paying independent contractors. Here’s how to avoid it.

• Review IRS Form SS-8. If you’re unsure about a worker’s classification, submit this form to the IRS for determination.

• Check state laws. Some states have additional requirements for classifying an employee vs. an independent contractor. For example, California has a strict “ABC test” for determining independent contractor status.

• Keep a paper trail. Use written contracts outlining project scope, deadlines, and payment terms to support your classification.

Some states, like New York and Illinois, impose additional rules for freelancers. For instance, New York City requires a written contract for any freelance job worth $800 or more.

The Compliance Checklist: What You Need Before Paying Contractors

Don’t issue a single dollar until these forms are in place. That’s how smart business owners protect themselves before any red flags fly. Here’s what you need to collect:

• Form W-9. Contractors complete this IRS form to share their legal name and Taxpayer Identification Number (TIN).

• A written agreement or contract. Don't skip this! A clear agreement outlining payment terms, project scope, deadlines, and how to handle disputes can save you from headaches down the road.

• Invoicing instructions. Work out the invoicing details up front to prevent confusion later. You and the contractor should agree on the invoice process, how often the contractor will bill you, and how you will pay them.

Once a contractor earns $600 or more from you in a calendar year, you must file Form 1099-NEC with the IRS by January 31.

How to Pay Contractors Without Overcomplicating It

So, you’ve got a signed agreement and the W-9 in hand. Now comes the big question: how to pay contractors reliably, affordably, and in a way that won’t land you in legal hot water.

Consider these methods:

• ACH direct deposit. Reliable and low-cost, especially for recurring payments.

• Business platforms. Use small business payroll platforms like Gusto, QuickBooks, or ADP can be used to manage payments and automate 1099s.

• Payroll processors. Even though they’re not employees, some payroll services also handle contractor payments.

Avoid using personal platforms like CashApp or Venmo for business transactions to prevent issues. These apps don’t provide IRS-compliant records, and mixing business with personal funds could threaten your LLC’s liability shield.

Avoid These Common Mistakes When Paying Independent Contractors

Most contractor payment issues don’t come from a lack of funds, but a lack of structure. Here are some avoidable missteps:

• Paying without a contract—opens the door to disputes or unpaid taxes

• Reimbursing expenses without receipts—could trigger IRS scrutiny

• Commingling personal and business accounts—jeopardizes legal protections

• Skipping 1099 filings—leads to IRS penalties and unnecessary audits

• Failing to verify work product—especially important with international or remote freelancers

Mistakes are part of entrepreneurship, but some are just too expensive to make twice.

What If I Misclassify a Contractor?

You may owe back taxes, interest, and penalties. If you correct the situation proactively, the IRS offers a Voluntary Classification Settlement Program (VCSP).

Paying International Contractors? Here’s What to Know

While hiring global talent can cut costs, paying international contractors can be more complicated. You’ll want to comply with U.S. tax rules and applicable international laws.

Steps to follow when working with overseas contractors include:

• Collect Form W-8BEN. This IRS form certifies the contractor is not a U.S. taxpayer.

• Use international-friendly platforms. PayPal Business, Wise, and Deel are secure and IRS-compliant.

• Double-check classification rules. Some countries have different labor classifications. A contractor in Nebraska could be considered an employee in New Delhi.

Be mindful of fluctuating exchange rates and transaction fees, which can eat into your budget if not planned properly.

Devon’s Story: Solo but Structured

Devon almost skipped the paperwork until a friend got audited. Running a side hustle offering virtual bookkeeping services from her apartment in North Carolina, she brought on two contractors: a blog writer in Texas and a VA in the Philippines. With no payroll budget, she used Wave for invoicing, Wise for international payments, and filed her 1099s through the IRS site free of charge. Devon’s business is prepared for growth and has avoided penalties by complying with IRS regulations.

Start Smart and Stay Legal 

Taking small steps to avoid larger issues in the future can simplify working with local freelancers or growing a remote team. 

Frequently Asked Questions About Paying Contractors

Do I Have to File a 1099 for Every Contractor?

Yes. You must file a 1099 if the contractor earns $600 or more during the year and is based in the U.S. Foreign contractors don’t get a 1099 but require a W-8BEN instead.

Can I Pay Contractors with a Personal Account?

You can, but you shouldn’t. Use a business account to protect your legal separation and simplify tax filing.

Resources:

• U.S. Equal Employment Opportunity Commission, Who is an Employee?, link.

• Persons performing service not authorized under this chapter deemed employees exception, M.G.L. c. 149, § 148B, link.

• New Jersey Department of Labor and Workforce Development, Independent Contractors and Misclassification, link.

• Internal Revenue Service, Reporting payments to independent contractors, link.

• Internal Revenue Service, Voluntary Classification Settlement Program, link.

• ADP, 1099 payroll – payroll for independent contractors, link.

• Wave, How to pay contractors: A guide for small businesses (March 2023), link.