Payroll How To Pay Independent Contractors

For many small businesses, using freelancers is an appealing alternative to taking on permanent members of staff. Firstly, it enables the business to take on and shed members of the workforce quickly and simply as demand dictates – particularly useful if the business has seasonal peaks and troughs. In addition to this, paying independent contractors (IC) is simpler in many ways than paying permanent employees. 

IC payment definition

There is no need to pay Federal Insurance Contribution Act (FICA) taxes for independent contractors, or to pay unemployment tax, but the simplicity that this offers does come with a caveat. This caveat is that any small business IC payment has to be carefully monitored in order to ensure that a worker has been classified correctly. 

The key to reaching the right IC payment definition lies in defining the relationship between your business and the worker – deciding whether they are an employee or an independent contractor. The good news is that the IRS has published guidelines businesses can consult when classifying their workers. In simple terms, if a business has control over the result of the work in question, but not the question of how and when the results are delivered, then the worker in question is an independent contractor rather than an employee. 

In order to make this decision, the IRS weighs up the following factors:

• Does the business have the right to control what the worker does and how they do it?

• Does the business control factors such as reimbursing expenses, how payments are made and the provision of any tools and equipment needed?

• How do the parties regard their relationship? Answering this might involve looking at things like written contracts and in-work benefits. 

If your business isn’t sure about how to classify a worker after weighing up these factors, you can deal with the situation by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding with the IRS.

How to make a small business IC payment

Once you’ve decided that a worker is definitely an independent contractor and negotiated the amount to be paid, the payment process will generally involve the following steps: 

• Obtain an independent contractor’s Form W-9, Request for Taxpayer Identification Number and Certification

• Pay the independent contractor in line with the terms agreed between the two of you

• If needed, remit any backup withholding payments to the IRS

• If the IRS sends a backup withholding notice to the business, then you will have to deduct 24% from future payments to the independent contractor

• If your business pays more than $600 per year to an independent contractor then you will have to complete Form 1099-NEC and give copies to the contractor and the IRS

Federal payroll taxes and independent contractors

An independent contractor is responsible for paying their own federal payroll taxes, which are also known as self-employment taxes. This tax is paid in two parts – 12.4% to Social Security and 2.9% to Medicare: a total of 15.3%. In some cases, an independent contractor may also have to pay state and local taxes. 

If the information and guidance provided by the IRS isn’t clear, you can also seek advice from agencies such as the Department of Labor. If your business makes a mistake when classifying a worker, the IRS can impose penalties in the form of penalties and taxes.

We Can Help

If you’re interested in finding out more about payroll issues, or any other aspect of your business finances, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.