What Every Business Should Know About Paying Contractors

Getting Contractor Payments Wrong Is More Common — and More Expensive — Than You Think

Misclassifying a worker, missing a 1099-NEC deadline, or paying an overseas contractor through the wrong rail can quietly cost a small business thousands in penalties, back taxes, and IRS scrutiny. None of it is complicated once you know the rules, but the rules are scattered across the IRS, the Department of Labor, HMRC, and half a dozen payment providers with their own quirks. Here's what actually matters.

Step One: Are They Really a Contractor?

Before any tax form matters, classification matters. The IRS, DOL, and most state labor agencies use overlapping but not identical tests, and getting this wrong is the single most expensive mistake on this list — misclassified workers can trigger back payroll taxes, unpaid overtime, benefits liability, and penalties going back years.

The IRS common-law test looks at three categories of control:

• Behavioral control — do you dictate how, when, and where the work gets done, or just the outcome? Contractors set their own methods and hours; employees follow your processes and schedule.
• Financial control — does the worker have unreimbursed expenses, their own tools, the ability to work for other clients, and a chance of profit or loss? Employees typically get reimbursed expenses and a guaranteed wage.
• Relationship type — is there a written contract describing the relationship as independent? Are benefits (health insurance, paid leave, retirement contributions) provided? Is the work indefinite/ongoing or tied to a specific project?

No single factor decides it — the IRS and courts weigh the whole picture. A few states go further: California's ABC test (Labor Code 2775, following AB5) presumes a worker is an employee unless the business proves all three: the worker is free from control, performs work outside the hiring company's usual business, and is customarily engaged in an independently established trade. That third prong alone knocks out a lot of arrangements — a marketing agency can't call a full-time in-house-style marketer a contractor just because they issue a 1099.

Get it wrong and the IRS can reclassify the worker retroactively, at which point you owe the employer share of Social Security and Medicare taxes, potentially federal unemployment tax, and penalties — plus whatever your state adds on top (California penalties under AB5 can run $5,000–$25,000 per violation for willful misclassification).

Step Two: Collect the Right Tax Form Before You Pay Anyone

Never send the first payment before you have this on file. It's much harder to chase down a signed form after the money's already out the door.

A W-9 is valid indefinitely unless the contractor's information changes. A W-8BEN generally needs renewal every three years. Keep these on file for at least four years after the last payment — that's the recordkeeping window the IRS expects you to be able to produce if audited.

Step Three: 1099-NEC — Thresholds, Deadlines, and What Trips People Up

As of the 2024 tax year, if you paid a US-based independent contractor $600 or more in the calendar year for services (not goods), you must issue Form 1099-NEC. Note: a new lower threshold of $2,000 was legislated for future years under recent tax law changes affecting 1099-K and related reporting — always confirm the current-year threshold on IRS.gov before filing, since thresholds have been adjusted more than once in recent years.

Key dates for the 1099-NEC:

• January 31 — deadline to send Copy B to the contractor
• January 31 — deadline to file Copy A with the IRS (this form doesn't get the usual February/March extension that other 1099s get — NEC is due to the IRS the same day as to the recipient)
• No automatic extension is generally available for 1099-NEC; Form 8809 extension requests are evaluated on a case-by-case, non-automatic basis for this form specifically

What doesn't need a 1099-NEC:

• Payments to a C-corporation or S-corporation (with limited exceptions like attorney payments, which are reportable regardless of entity type)
• Payments made via credit card, debit card, or third-party payment network (PayPal, Venmo for business, most modern platforms) — these get reported by the payment processor on Form 1099-K instead, so you don't double-report. This is the most common point of confusion: if you paid a contractor entirely through a card or a network like PayPal Business, you typically don't also send a 1099-NEC for those same payments.
• Payments for goods/merchandise rather than services
• Payments under the $600 threshold in total for the year

Penalties for missing the deadline scale with how late you are: $60 per form if filed within 30 days late, $130 per form if filed by August 1, and $330 per form after that — rising to $660 per form for intentional disregard, with no cap in the worst cases. These are per-form penalties, not per-business, so a company that's late on fifteen 1099s can rack up a real bill fast.

Paying Overseas Contractors

Hiring internationally is now routine, but the tax and payment mechanics differ meaningfully from domestic contracting.

Tax withholding: Payments to foreign contractors for services performed entirely outside the United States are generally not subject to US withholding or 1099 reporting, provided you have a valid W-8BEN or W-8BEN-E on file establishing foreign status. If the work is performed inside the US (even by a non-citizen), US-source income rules can trigger 30% withholding unless a tax treaty reduces it.

Payment rails: Wire transfers work everywhere but are expensive ($15–$50 per transfer) and slow (1–5 business days). For recurring contractor payments, most growing businesses use:

• Wise (formerly TransferWise) — strong for multi-currency payouts with transparent, low FX margins
• Payoneer — popular with freelance marketplaces and contractors in emerging markets who need a local receiving account
• Deel, Remote, or similar Employer-of-Record/contractor-management platforms — handle classification risk, contracts, tax form collection, and payment in one flow, useful once you're paying more than a handful of overseas contractors regularly
• PayPal — convenient but carries the highest fees (often 3–5% plus FX spread) for cross-border payments

Whichever rail you use, keep records of the exchange rate and USD-equivalent value of every payment — you'll need this for your own bookkeeping even though you're not issuing a 1099 to a foreign contractor for offshore work.

A Note on UK IR35

If you're a UK business engaging contractors through their own limited company (a "personal service company"), IR35 (the off-payroll working rules) determines whether HMRC treats that engagement as disguised employment for tax purposes. Since April 2021, medium and large private-sector clients (broadly, companies meeting two of: turnover over £10.2m, balance sheet over £5.1m, more than 50 employees) are responsible for determining the contractor's IR35 status themselves and must issue a Status Determination Statement (SDS) for each engagement. Small companies below those thresholds are exempt from this responsibility — the contractor's own limited company still self-assesses status in that case.

Getting the status determination wrong, or failing to issue an SDS with reasonable care, shifts liability for unpaid tax and National Insurance contributions to the client business, not just the contractor — this is the single biggest change from the pre-2021 rules and catches out businesses that assume IR35 is "the contractor's problem."

Key IR35 status factors mirror the US common-law test closely: control over how work is done, right of substitution (can the contractor send someone else to do the work?), and mutuality of obligation (is the business obliged to offer work and the contractor obliged to accept it?). HMRC's CEST (Check Employment Status for Tax) tool gives a non-binding assessment and is a reasonable starting point, though it's been criticized for oversimplifying borderline cases.

Contracts: Don't Skip This for a "Quick" Project

A written independent contractor agreement should cover, at minimum:

• Scope of work and deliverables (specific enough that "done" is unambiguous)
• Payment terms — rate, invoicing schedule, currency, and what happens on late payment
• IP ownership — who owns the work product, and when ownership transfers (on final payment is common and protects you if payment is disputed)
• Confidentiality and, where relevant, non-solicitation
• Termination terms and notice period
• An explicit independent-contractor clause stating the contractor is responsible for their own taxes, insurance, and benefits — this doesn't override the substance-over-form classification tests above, but it documents intent and matters as one factor among several

Skipping the contract doesn't just create legal risk on IP or scope disputes — it also removes one of the "relationship type" factors that supports contractor classification if the IRS or a state agency ever asks questions.

Payment Rails: Matching the Tool to the Volume

At meaningful scale, the cost of a platform is almost always lower than the staff hours spent chasing tax forms manually every January — and it materially reduces the odds of a missed filing deadline.

Recordkeeping: What to Keep and For How Long

Beyond the W-9/W-8BEN forms themselves, hold onto signed contracts, invoices, proof of payment (bank statements, platform transaction records), and any correspondence about scope changes for at least four years from the date of payment — longer if your state has a longer statute of limitations for wage or tax claims. If you ever face an IRS inquiry or a state misclassification audit, the contractor's own invoices showing they set their own rate, worked for other clients, and used their own equipment can be some of the strongest evidence supporting your classification decision.

State-Level 1099 Filing Quirks

Some US states require their own copy of the 1099-NEC in addition to the IRS federal filing, and a few participate in the Combined Federal/State Filing Program, which forwards your federal filing automatically. Others — including a handful with no state income tax — don't require a separate state filing at all. Because the list changes periodically, check your specific state's department of revenue guidance each filing season rather than assuming last year's requirement still applies. Missing a state-level requirement typically carries its own penalty schedule, separate from the federal one.

FAQ

Do I need a W-9 from every contractor, even for a one-off $200 job?

It's good practice to collect one regardless of amount, since you won't always know at the start of the year whether total payments will cross $600. Collecting it upfront avoids chasing someone down in January.

What if a contractor refuses to provide a W-9?

You're required to backup withhold 24% of payments and remit it to the IRS until you receive a valid taxpayer ID. Most contractors provide the form once they understand this.

Do LLCs get a 1099-NEC?

Single-member LLCs and multi-member LLCs taxed as partnerships generally do get a 1099-NEC if they're paid $600+ for services. LLCs that elect S-corp or C-corp tax treatment generally don't, similar to corporations — check the W-9's tax classification box, since that's what determines it, not the "LLC" label alone.

Is a 1099-NEC the same as a 1099-MISC?

No. Since 2020, non-employee compensation moved off the 1099-MISC and onto its own form, the 1099-NEC. The 1099-MISC still exists for things like rent, prizes, and legal settlement proceeds, but not for standard contractor payment for services.

Do I withhold tax for domestic US contractors?

Generally no, unless backup withholding applies (missing/incorrect TIN, or IRS notification of underreporting). Contractors handle their own income tax and self-employment tax through quarterly estimated payments.

How do I pay a contractor in a country with US sanctions or restrictions?

Check OFAC's sanctions list before engaging any contractor in a restricted jurisdiction — most payment platforms will block the transaction automatically, but the compliance responsibility sits with your business, not the platform.