Sometimes your business needs help, but you don't have enough work for a full-time employee. And sometimes, your company needs help but you don't have the funds to hire someone permanently.
If you find yourself in either of these situations, an independent contractor could be the solution.
In recent years, the rise of the gig economy has led to an increase in workers classified as independent contractors. According to an IRS study, there has been a 22% increase in taxpayers reporting income as independent workers since 2001.
1099 contractors, also known as freelancers or consultants, aren't technically employees. So, there are different rules for paying them. Before you hire your first freelancer, familiarize yourself with how to pay an independent worker.
Keep reading to learn:
- What an independent contractor is
- How to decide whether to hire an independent contractor or an employee
- The six steps involved in paying a 1099 contractor
- How much independent workers have to pay in taxes
What Are Independent Contractors and How Are They Different from Employees?
Independent contractors are people hired to work for your company on a temporary, contractual basis. According to the IRS, businesses that hire independent contractors can only control the result of the work, but not how the contractor works.
For example, you might hire someone as a 1099 contractor to design a website for you. You can control what you want your website to look like, but you can't tell the designer to work from your office or use a specific methodology to do their job.
1099 contractors work on their own time, as long as they complete the agreed-upon deliverables to the client's satisfaction.
Alternatively, employers can control what their employees do and how they do it.
An employee shows up to the office at a specific time, works for a particular number of hours, and does what their employer asks. Most white-collar, full-time workers are classified as employees rather than independent contractors.
Most importantly, as a business owner, you need to be aware that the IRS classifies employees and 1099 contractors differently.
Independent contractors are responsible for taking care of their own taxes. Therefore, you won’t have to withhold taxes for freelance consultants. However, when you hire an employee, you must withhold and subsidize their payroll taxes.
When Should You Hire an Independent Contractor and When Should You Hire an Employee?
You should hire independent contractors for temporary tasks or jobs that don't require full-time hours. 1099 contractors are useful when you need a specific project done, but won't need that person once the project is over.
For example, let's say that you need a new logo for your restaurant. Unless you will have ongoing visual design needs, it doesn’t make sense to add a graphic designer to your team. Instead, you should hire a freelance graphic designer for the specific purpose of creating your new logo.
This freelancer isn't an employee of your business.
You won’t provide your graphic designer with benefits or have to withhold their taxes. They no longer work for you after the deliverables are received. If you want to use their services again, you simply hire them for the next project.
If you find yourself frequently using an independent worker, you may decide to bring them on permanently. Working with a freelancer can be a test run before adding them to your company as an employee.
Let's say that you have an accounting firm, but so far, you're the only one who works there. You want to add a bookkeeper to free up your time, but you're wary of bringing on a full-time employee because you've never managed someone before. You can test the waters by hiring a freelance bookkeeper to help you with several projects.
Work with your bookkeeper in a freelance capacity until you've gotten the hang of management. Eventually, you can decide if adding the bookkeeper to your team would benefit your business in the long run. If so, you can then reclassify them as an employee.
So when should you hire an employee, as opposed to an independent contractor?
Whereas 1099 contractors solve temporary needs, employees are there for the long term. Hire an employee when you have an ongoing need for their help.
How to Pay Independent Contractors in a Small Business
Here's the good news:
Paying independent workers is more straightforward than paying employees. Here's how to pay independent contractors in six simple steps.
1. Decide on Compensation
First, determine if you will pay your contractors a set fee or hourly rate.
Project fees are more predictable than hourly rates. Collaborate with the contractor to define the scope of the work and make sure you know what you'll be getting in exchange for your money.
Hourly compensation can soar when a project takes longer than anticipated. If you do decide to pay hourly, independent contractors typically set their rates and can give you an estimate for how long the job will take.
2. Decide How Often to Pay Your Independent Workers
If you're paying your contractor a project fee, you could pay them for the entire project after they've finished it. Or you could pay them incrementally when they reach milestones.
For example, if you're hiring a contractor to paint five houses for you, you could pay them after they've painted each house, or once all the houses are finished.
If you're paying your freelancers hourly, it's convenient to pay them when you run payroll for your other employees. Just make sure not to withhold your contractors' taxes. We'll go over this in more detail in step number five.
Ultimately, it’s best to collaborate with your freelancer to settle on a mutually beneficial payment schedule. A consultant-client relationship is less like a boss-employee relationship, so your contractor has more say over things, like when and how you pay them.
3. Collect Taxpayer Identification Numbers
Ask the consultant to fill out an IRS form W-9 to collect taxpayer information, like their social security number (SSN) or employer identification number (EIN).
If you're paying the 1099 contractor via direct deposit, you'll also need to collect their bank account details.
4. Request an Invoice
Unlike the employees you automatically pay each payday, independent workers send you invoices to initiate payments for their services. After you decide how often your freelancers will charge you, ask them to send you invoices on the dates or milestones that you agreed to pay them.
The invoice can be a simple document that states the services the freelancer rendered and how much money you owe them. If you're paying your independent worker hourly, ask them to attach an itemized timesheet to the invoice to justify how they spent their time.
Keep copies of invoices to help your small business with its recordkeeping.
5. Pay your 1099 Contractors
Now we come to the easy part: paying your independent contractors. It's more straightforward to pay independent workers than employees.
To pay employees, you have to calculate their tax withholding, so the amount you pay them is less than what they've earned.
Suppose a Los Angeles-based employee makes $2,115 in one pay period. You’ll pay them about $1,600 with the remaining $515 going toward federal and state income and FICA taxes.
Because 1099 contractors aren't employees, you don't have to withhold their taxes. Instead, you pay them the full amount requested on their invoice.
If an independent worker bills you $2,115, you pay them $2,115.
Decide with your freelance consultant how they'll get paid. Do they want a check or a direct deposit? Cut their check or make the bank transfer to ensure your contractor receives the amount shown on their invoice.
You’ll request invoices and issue payment until your contractors finish working for you.
6. Send a 1099 at the Start of Tax Season
By the end of January, send an IRS form 1099 NEC (new for 2020, used to be 1099-MISC) to any 1099 contractor that you paid $600 or more during the year. You’ll report nonemployee compensation in box 1.
Specific deadlines to keep in mind include:
- Send 1099 NEC to independent contractor by 1/31
- On paper: File 1099 NEC with IRS by 2/28
- Electronically: File 1099 NEC with IRS by 3/31
An accountant can generate a 1099 form for you, or if you use payroll software like Hourly, the software will automatically send the form to your independent workers.
How Much Do Independent Contractors Have to Pay in Taxes?
Self-employed people owe the government:
- Federal income taxes
- State income taxes
- Local income taxes (if applicable)
- FICA taxes for Social Security and Medicare
Because employers don't withhold their taxes, independent contractors must make quarterly tax payments. Their tax burden is based on the tax bracket they land in at the end of the year.
For example, if an unmarried independent worker earned $82,000 in 2019, they are taxed at a 22% rate and need to pay $4,510 in quarterly tax payments to the federal government.
FICA tax rates are the same for everyone: 15.3%. However, employers split this tax burden with their employees. So, employers pay 7.65%, and employees pay 7.65%.
Independent contractors are responsible for paying the full 15.3% in FICA taxes, also known as self-employment taxes. That breaks down to 12.4% for Social Security taxes and 2.9% for Medicare taxes.
Final Thoughts: How to Pay 1099 Contractors in a Small Business
Paying employees involves withholding taxes, whereas paying independent workers consists of giving them the full amount they request on their invoices. Paying freelancers is ultimately simpler than paying employees.
If you're a small business owner who wants to make life even simpler, try using payroll software to pay your 1099 contractors and employees. You can test out Hourly for free.
1. Introducing Yourself
Your introductory email needs to pack a lot of information into a small package. Try something like this:
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Hello Jane,
My name is John Doe and I work for ABC Agency, where we provide business insurance policies to many of Dallas' rockstar small businesses.
Congratulations on your new business, Jane's Bakery. Are you wondering if you have all the insurance you need? Or if your policies will really cover you in a pinch?
At ABC Agency, we pride ourselves on providing robust, comprehensive coverage options to companies like yours with flexible, pay-as-you-go plans.
Are you available this week to talk more about how we can help? I can help you find the most affordable rates and the best policies out there.
I look forward to speaking with you soon.
Cheers,
John Doe
2. Presenting a Quote
Once you've met with your potential client, a quick reply with their quote will get the ball rolling.
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Hi Jane,
Thanks so much for meeting with me this morning. I loved touring Jane's Bakery–I can still smell those delicious chocolate chip cookies baking! You have a great location, and I'm sure you're going to do great on Front St.
After reviewing my notes, I've pulled together an insurance quote for you (attached). I recommend a business owner's policy. A BOP includes several insurance products in one: liability, property insurance, and business interruption insurance. It offers robust coverage at a competitive price.
I'll call you in a few days to see what you think about this insurance plan. In the meantime, if you have any questions, don't hesitate to email me or call me at [phone number].
Again, thank you for your time today. I look forward to working with you in the future.
Cheers,
John Doe
3. Thanks for Purchasing a Policy
Gratitude is important! It's never a bad idea to thank your clients for their business.
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Hi Jane,
Thank you for choosing a business owner's policy with ABC Agency. We know it's so important to get the right coverage for your business, and we are honoured you've placed your trust in us.
We're excited to work closely with you, and our no. 1 goal is to make sure you're business is always protected.
Do you have any questions? We are here to help. Reach out whenever something comes to mind.
Thank you again for choosing ABC Agency to insure Jane's Bakery.
Cheers,
John Doe
4. Welcome Email
A welcome email helps clients feel like you're there to help–and can softly pitch other insurance products you offer.
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Dear Jane,
Welcome to the ABC family! We are thrilled to have you as a new customer and can't wait to meet all of your insurance needs.
As an independent insurance agency, we work with multiple insurance providers to find the best coverage options for all our customers. If you need any other type of insurance–like [include additional offerings unique to your agency, like life insurance, health insurance, home insurance or anything else]–we can help you too.
Do you want to discuss any of these policies?
Cheers,
John Doe
5. Introducing a New Product
A happy client may want to expand their business with you.
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Hello Jane,
I hope all is well with you and Jane's Bakery. I stopped in yesterday for a blueberry muffin and coffee, and they were delicious. I loved the hint of cinnamon in the muffin! Was that your idea?
I wanted you to be the first to know we are now offering commercial vehicle insurance to our policyholders. Auto insurance for your catering vans is super important since your personal car insurance won't cover them.
We're offering this insurance coverage solely to our current business clients at the moment and have some very competitive rates.
Would you like me to work up a quote for you?
As always, thanks so much for being a part of the ABC family.
Cheers,
John Doe
6. Asking For Referrals
Once your relationship is established and comfortable, let your clients help you grow.
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Hi Jane,
You've been a valuable member of the ABC family for two years now, and we so appreciate your business–not to mention the muffins you supply for our monthly meetings!
Because you are a valued policyholder, I wanted to ask a quick favour. I know you are active in the local Chamber of Commerce, and I'm hoping you might know some colleagues who would benefit from working with our insurance company.
Referrals are one of the most effective ways to connect with our community since people really trust their friends, family and colleagues. Is there anyone you'd recommend I speak with?
Remember that in addition to business insurance products, we offer everything from life insurance policies to pet insurance.
As a thank you for your help, we will send you an Amazon gift card of $100 when your referrals buy insurance from us.
Thanks so much for your help!
Cheers,
John Doe
7. Policy Renewal
If your client needs to renew their policy with you, send an email like this:
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Hi Jane,
I hope you're doing well! What a year it's been—from being listed as one of the top 5 bakeries in Dallas to being an official vendor for the city—you have so much to be proud of.
Just a heads up that your business owner's policy is up for renewal soon and will expire on June 15, 2023.
If you're still happy with the coverage, we can easily renew it for you.
Do you have some time to chat this week?
Looking forward to serving you again!
Cheers,
John Doe