How to Pay Independent Contractors: A Step-by-Step Guide

The first contractor I ever paid was a designer, and I paid her the way most founders do: she sent an invoice, I sent money, we both moved on. It felt like buying something. In a sense it was.

What I had not done was collect a W-9, and in January I needed her taxpayer identification number to file a 1099. She had finished the project, taken a full-time job somewhere else, and was answering emails at roughly the speed you would expect from someone with no remaining incentive to help me. It took three weeks. It should have taken one email, sent before the first payment.

Paying a contractor is genuinely simple, and it is also full of small procedural things that are trivial in advance and painful in arrears. This guide walks the whole sequence: confirming they are actually a contractor, collecting the W-9, agreeing terms, choosing a payment method, and filing the 1099. It also covers the fact that the 1099 threshold just changed for the first time since 1954, which most articles on this topic have not caught up with yet.

Before You Pay Anyone

Two things need to happen before money moves, and both are cheap to do upfront and expensive to fix later.

The order matters: classification, then W-9, then payment. Do it in a different order and you will be negotiating with someone who has already been paid, which is a much worse position than negotiating with someone who has not.

Step 1: Confirm They Are Actually a Contractor

This is the step people skip, and it is the one that carries the largest liability. Calling someone a contractor does not make them one.

Per IRS guidance on independent contractor versus employee status, the determination turns on the degree of control and independence in the relationship, evaluated across three categories.

How to Pay a 1099 Employee

There is no such thing as a 1099 employee. The phrase is everywhere, and what people mean by it is an independent contractor: someone you pay in full against an invoice, with nothing withheld, reported at year end on Form 1099-NEC instead of a W-2. The process is the one on this page.

The wording matters because the two halves of the phrase describe opposite obligations. A worker is either an employee, with withholding, overtime, and payroll tax sitting on your side, or a contractor, with none of it. If somebody seems to sit in the middle, that is not a third category. It means the classification has not been settled yet.

Step 2: Collect the W-9 Before You Pay a Dollar

Form W-9 is how the contractor gives you the information you will need to report the payments: their legal name, business name if they have one, entity type, address, and taxpayer identification number.

The form is short, the contractor fills it out, and you keep it. You do not send it to the IRS. It sits in your files until January, when it becomes the thing that makes filing a 1099 possible.

Here is the argument for collecting it before the first payment rather than when you technically need it. The reporting obligation only arises once you cross the threshold for the year, and in January you cannot know whether a given contractor will cross it by December. More practically, your leverage evaporates the moment you pay them. Before payment, the W-9 is a condition of getting paid. After payment, it is a favor you are asking of someone who no longer needs anything from you.

What Forms an Independent Contractor Fills Out

For a US-based contractor there is exactly one IRS form to complete for you, and it is the W-9. Everything else in the paperwork either comes from you at year end or gets filed by the contractor on their own return. Here is the full set, and who is responsible for each piece of it.

Step 3: Agree the Terms in Writing

A contractor agreement does two jobs. It prevents the commercial disagreement, and it evidences the classification.

Step 4: Pick a Payment Method

Four realistic options, and the differences that actually matter are cost, speed, and what record they leave behind.

Setting a Contractor Payment Schedule

Pay against invoices on stated terms rather than on a calendar you set for them. Net 15 or net 30 from the invoice date is the normal arrangement, and on longer projects a deposit up front with the balance on delivery, or a fixed amount per milestone, keeps both sides honest about progress.

That last caution is worth keeping in view. Paying a set amount on a set day regardless of what was delivered is one of the facts read as financial control, and the agreement is where you show the arrangement was priced for a defined scope rather than for hours of availability.

The Best Way to Pay Contractors

For anyone you pay more than once: ACH or contractor payment software. That is the whole answer, and the reasoning is not really about the payment.

Any method moves money. What separates them is the record they leave. In January you need to know, per contractor, exactly how much you paid them across the entire year, and you need their W-9 to hand. A method that produces that automatically is worth far more than a method that saves you a two percent fee, because the two percent is a known cost and the missing record is an unknown one.

Setting up direct deposit for a contractor takes one form. Collect a signed authorization carrying their routing and account numbers, store it alongside the W-9, and run the payment through your bank or your payroll provider. Allow a day or two of lead time on the first run, since ACH settles in one to three business days rather than instantly.

The payment app case deserves a specific warning. Paying a contractor through a third-party payment network can generate a Form 1099-K from the platform, and that does not discharge your own 1099-NEC obligation. You can end up with two forms describing one payment, which confuses the contractor, confuses you, and creates a reconciliation problem nobody wanted.

What You Do Not Withhold

This is the sharpest practical difference between paying a contractor and paying an employee. You do not withhold taxes from a contractor. No federal income tax, no Social Security, no Medicare. You pay the invoice amount, in full, and the contractor handles their own tax.

There is one exception, and it is the reason the W-9 matters so much. Backup withholding, currently 24 percent, applies where the payee fails to furnish a taxpayer identification number, furnishes an obviously incorrect one, or where the IRS notifies you that the number does not match. In that situation you are required to withhold and remit, and the contractor gets less money because they did not fill in a form.

Read that table as a cost comparison and the incentive to misclassify becomes obvious, which is exactly why the IRS scrutinizes it. Every row where you owe nothing for a contractor is a row where you owe something for an employee, and the difference is not a rounding error.

Who Pays the Payroll Taxes Instead

Independent contractor payroll taxes do not disappear. They move to the contractor, who owes self-employment tax at 15.3 percent of net earnings, made up of 12.4 percent for Social Security up to the annual wage base and 2.9 percent for Medicare with no cap, which is both halves of what an employee and an employer otherwise split.

Contractors remit that themselves in quarterly estimated payments rather than through anything you operate, and an extra 0.9 percent of Medicare tax applies once earnings pass the threshold for their filing status. It is also why an hourly contractor rate that looks generous beside an employee wage is closer to even than it first appears.

Your side of it is short: no deposit schedule for that person, no line for them on your quarterly employment tax return, and no W-2 in January. The one figure you do have to keep is the running total of what you paid them, and that is a reporting job rather than a tax one.

The New $2,000 1099 Threshold

Here is the part most articles on this topic still have wrong, because the number they are quoting was correct for seventy years and stopped being correct very recently.

Section 70433 of the One Big Beautiful Bill Act amended Internal Revenue Code section 6041 to raise the reporting threshold for Form 1099-NEC and Form 1099-MISC from $600 to $2,000, effective for payments made after December 31, 2025. Beginning in 2027 the figure is indexed for inflation. Prior to this, the $600 figure had stood unchanged since 1954.

Two details that matter more than the headline. First, the threshold is per contractor, per calendar year, in aggregate. Four payments of $600 to the same person is $2,400, which is over the line, even though no individual payment was close. Second, the income is still taxable below the threshold. The change alters who has to file a form. It does not make the first $1,999 tax-free for anyone.

You can also still file voluntarily below the threshold, and plenty of businesses do, because it supports their own records and helps the contractor document income. Nothing prevents it.

Whichever number applies to you, the tracking is the same job: a running total per person that you can read in one line. The workbook below keeps quarterly subtotals against the year total, flags who has crossed the line, and records the W-9 and agreement dates that make the January filing possible.

Step 5: File the 1099-NEC

Form 1099-NEC reports nonemployee compensation. If you paid a contractor at or above the threshold during the calendar year, you file one for them and send them a copy.

Your State May Disagree With the IRS

The federal threshold tells you what the IRS wants. It tells you nothing about what your state wants, and states are actively diverging on this.

Some states conform to the federal Internal Revenue Code automatically and have picked up the new $2,000 figure. Others have kept their own thresholds, and some of those are lower than the federal one, which means a payment that generates no federal filing obligation can still generate a state one. A handful of states require you to file directly with them regardless of whether you filed federally through a combined program.

The practical guidance for a small business is unglamorous: if you pay contractors in more than one state, check each one, and check it again this year, because this is a moving target. Do not assume the federal change propagated everywhere.

Paying Foreign and International Contractors

A contractor outside the United States runs on a different set of forms. They do not give you a W-9 and they usually do not receive a 1099-NEC. What replaces both turns on a single question: where the work was physically performed.

Per IRS guidance on the source of personal service income, compensation for services performed in the United States is US-source income, and compensation for services performed abroad is foreign-source. The contract, the currency, and your own location do not decide it. The place the person was sitting while working does.

That one fact drives everything else. A developer in Poland who never sets foot in the US is earning foreign-source income, which sits outside US withholding and outside 1099 reporting. The same developer spending three weeks working from your office has earned US-source income for those three weeks.

Form W-8BEN is the foreign counterpart of the W-9. The contractor certifies that they are a foreign beneficial owner and gives you what you would need if withholding ever applied. Entities file W-8BEN-E instead. Collect it before the first payment, for the same reason you collect a W-9 before the first payment.

Where withholding does apply, the statutory rate is 30 percent of the US-source amount, reduced or removed where a tax treaty covers the country the contractor lives in. Treaty relief is something the contractor claims in the withholding paperwork. It does not apply automatically just because a treaty exists.

The IRS is explicit that nonemployee compensation paid to nonresident aliens is reported on Form 1042-S rather than Form 1099-NEC. An international contractor is never simply a domestic 1099 with a foreign address, and the tool you use for domestic contractors may not produce a 1042-S at all.

Moving the money is the easier half. Wires cost more per transaction and land the same day, while cross-border payment platforms are cheaper on small amounts and usually take a margin on the currency conversion. Agree in the contract which currency the invoice is in and who absorbs the transfer fee, because that is a miserable argument to have afterwards.

Mistakes That Cost Real Money

Notice how many of these are procedural rather than conceptual. Nobody misunderstands what a W-9 is. They just do not collect it, because at the moment of the first payment it feels like unnecessary formality between two people who trust each other. The formality is not for that moment. It is for January.

Doing This Without an HR Team

The steps are easy. The failure mode at a small company is always the same: the W-9 is in an email, the agreement is in a different email, the payments went out of three different accounts, and nobody has added up what any single contractor was actually paid this year.

This is where FirstHR fits. Document management with e-signature collects and stores the W-9 and the signed agreement where they can actually be found in January. Employee and contractor profiles hold the classification decision and the reasoning behind it, so it is a record rather than a memory. Task workflows make collecting the W-9 a step in engaging a contractor rather than a thing someone meant to do.

FirstHR is not a payments platform and does not move money or file your 1099s; that stays with your payroll or accounting provider. What it holds is the document and classification layer around the payment, which is the part that goes missing and the part that costs you when it does. None of this is legal or tax advice, so confirm your classifications and your state filing obligations with a qualified advisor.

Frequently Asked Questions