April 22, 2021Payroll

The best way to pay independent contractors

Businesses everywhere are paying independent contractors—they’re the worker of choice for seasonal services, door-to-door companies and the growing gig industry. With more independent contractors being hired, you need the right policies and tools to utilize 1099 employees in your business. This means looking at existing processes, determining the best way to pay independent contractors and utilizing efficient payment methods. 

Paying independent contractors

Because businesses aren’t required to pay certain taxes or provide benefits, paying independent contractors can be viewed as less expensive and complex than W-2 employees. However, this means independent contractors are evaluating businesses less on the total package of compensation and more on wages and their overall pay experience.

This guide will explain the best way to pay independent contractors by covering the following: 

How to pay independent contractors

Paying independent contractors can mean significant cost savings for employers. While independent contractors may charge higher hourly rates, paying independent contractors is usually less expensive than the cost of a W-2 employee. This is because businesses are not required to do the following for independent contractors: 

  • Pay social security, medicare or unemployment taxes 
  • Offer disability, unemployment or worker’s compensation insurance 
  • Provide health or dental benefits 
  • Pay overtime or hazard rates
  • Offer paid time off, sick leave or vacation time
  • Provide equipment to perform tasks, such as a laptop
  • Offer direct deposit for contractors 

IRS forms for paying independent contractors

While paying independent contractors may be less intensive than W-2 employees, you must file the proper worker paperwork with the IRS

Form W-9

A W-9 form collects basic information from independent contractors like name, address and taxpayer identification number (TIN). If the independent contractor is not operating as a business entity, such as a corporation or partnership, the TIN will be their social security number. It’s best practice to receive the completed W-9 form before the independent contractor begins work, and it should only be resubmitted in the event that the information has changed. 

Form 1099-NEC

Form 1099-NEC must be filed with the IRS and given to independent contractors who are paid more than $600 in a calendar year. It should also be issued to the contractor who performed the work. Essentially, a 1099-NEC form declares how much an independent contractor has been paid.

How do independent contractors get paid?

Once the proper paperwork is in place, you will need to work out a payment option with your independent contractor. Some independent contractors are paid based on an hourly rate while others work off of a retainer fee or commission-based compensation plan. The best payment arrangement for independent contractors vary, but these are some common options: 

1. Hourly rate

Some independent contractors charge per hour of work performed. The worker may record their own hours and provide an invoice or a business may provide time tracking software for the independent contractor to record their timesheets. 

Hourly rates are common among independent contractors acting as consultants or advisers, like a lawyer or business strategist. In many cases, the hourly rate for contracted work may be higher than the calculated hourly rate of a W-2 employee to account for the 15.4% of taxes an independent contractor is responsible for paying to the IRS. 

Hourly rates are typically best for: service workers, landscapers, caregivers, caterers, coaches and advisors. 

2. Per project fee

Instead of paying an hourly rate, you may decide to pay independent contractors based on the overall value of a finished project. It’s typical to pay a down payment before a project begins and then paying the full amount upon completion of the work. You can also pay set amounts when certain project milestones are reached. 

Project fees are typically best for: general contractors and tradespeople, artists, certain technical workers, designers, event planners, writers and other contractors working on one-time engagements. 

3. Retainer fee

For ongoing work, you may consider paying an independent contractor on retainer. A retainer essentially secures the availability of the independent contractor in advance of the work being performed. Retainers usually have a set time period the work must be executed, e.g. a monthly or quarterly retainer agreement. Independent contractors may favor retainers in order to better manage their cash flow planning. 

Retainer fees are typically best for: lawyers, certain technical workers, marketing professionals, business strategists and PR experts. 

4. Commission 

Commission payments are determined by the performance of the independent contractor. Commission-based payments can be based on a percentage of total sales or delivering a certain volume of sales. 

Commission payments are typically best for: real estate professionals, recruiters and other staffing professionals, sales representatives, multi-level-marketing consultants and door-to-door salespeople. 

The best way to pay independent contractors

The best way to pay independent contractors is to match the pace of contract work: fast and with flexibility. Fast payment tools are preferred for independent contractors who are looking to maximize their time and work in flexible environments. Paying independent contractors using outdated methods like checks and wire transfers create time delays and complications that could negatively impact a contractor’s desire to continue a working relationship.

Direct deposit for contractors

Given the Covid-19 pandemic and more people working remote, direct deposit for contractors is increasingly popular. Direct deposit means depositing money into a bank account electronically instead of using a paper check. “Electronically” means through the Automated Clearing House (ACH) network from the businesses bank account to the independent contractor account. 

Same day ACH vs. standard ACH

Same day ACH, also known as real-time payments or instant payments, is a service offered by some financial institutions and platforms that allow funds to be transferred from one account to another on the same business day. This is in contrast to standard ACH transactions which can take 3-5 days before they’re cleared. The main advantage of using same day ACH over standard ACH is time; independent contractors will receive their money faster with same day processing than the typical three or four days. 

Same day ACH transactions are superior to Standard ACH transactions for a number of reasons: the funds will be available within hours, not days; it is more secure because all transfers must go through an authorization process and there is no need to worry about forged signatures or fraud since everything happens electronically.

Paying independent contractors by check 

Paying independent contractors via check is becoming less popular because they’re viewed as highly inefficient for employers and logistically complicated for workers.

Processing paper checks means payroll admins must process payroll and then receive a packet in the mail from a payroll vendor a few days later with actual physical checks inside. The payroll team then manually distributes the checks to independent contractors via in-person drop-off or mail. If someone is out of the office etc., an admin must hold onto the check until a delivery can be made. This causes a security concern of what to do with the physical check.

Keeping track of a check before it’s deposited also adds additional complexity for independent contractors. Workers may lose their checks before they’re deposited meaning a new one needs to be issued, which is time-consuming and frustrating for both employer and contractor. 

Paying independent contractors via wire transfer

Wire transfers are typically used for large transactions, but they can also be used to pay independent contractors—though not as common. Wire transfers work by taking money from one person’s bank account and depositing it into another person’s bank account, usually through a wire transfer company like Western Union. Though some companies can make wire transfers same day, they can take up to three days for funds to transfer and typically include a transfer fee. 

Paying independent contractors online

It’s no secret that many people are moving away from using cash and instead opting to use apps like Venmo, Paypal or CashApp for fast, peer-to-peer payments. Though popular and practically instant, these types of apps are not meant for business transactions.

If you’re a small business owner, it might be tempting to pay independent contractors through Venmo or Paypal, because it’s easier than checks or other traditional methods. However, most of these apps forbid use for business transactions without authorized accounts and fees. For example, online payment app Paypal charges fees for transactions and currency conversion rates in certain markets, which might result in independent contractors receiving less of what you had anticipated as their final wages.

Digital payment apps may conveniently disperse funds, but keeping track of payments and manually entering data into your accounting or bookkeeping tools is inefficient for business owners.

Fast pay is the best pay for independent contractors

Modern businesses today use flexible pay software to pay independent contractors quicker than the standard two-week pay cycle reserved for W-2 employees. In the 2021 Gig Worker Survey, 91% of independent contractors said they prefer a pay frequency other than the traditional bi-weekly schedule, and 1 in 3 of said they would choose to be paid every day if given the option.

Utilizing direct deposit and same day ACH, independent contractors can be paid everyday for their work, which boosts worker satisfaction and retain rates. It’s an attractive benefit for independent contractors who aren’t eligible for insurance or vacation time due to their work status.

As companies look to scale more efficiently and competition for independent contractors increases, businesses can turn to fast pay as a perk that attracts workers who are seeking the most favorable business environment. Whether you’re paying an independent contractor hourly, per project or any number of payment options in between, businesses should focus on fast pay to attract and retain the best independent contractors.

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