Contractor vs. Employee: Key Difference
The single most important rule: independent contractors are responsible for paying their own taxes. You pay the contractor their full agreed rate, issue a 1099-NEC if the total reaches $600 for the year, and your tax obligation ends there. You do not withhold income tax, Social Security, or Medicare — the contractor handles all of that through self-employment tax and estimated quarterly payments.
Employees, by contrast, require payroll tax withholding, employer FICA contributions, unemployment insurance (FUTA/SUTA), and W-2 filing. The administrative and financial burden of employees is substantially higher than contractors, which is why the IRS scrutinizes contractor classifications carefully.
Before proceeding with any contractor arrangement, be confident the relationship genuinely qualifies as independent contracting. See the misclassification section below for the IRS's classification tests.
Collecting Form W-9
Before making your first payment to any contractor, obtain a completed Form W-9 (Request for Taxpayer Identification Number and Certification). This form provides you with the contractor's legal name, business name (if different), address, taxpayer identification number (SSN or EIN), and certification that the information is correct.
W-9 collection is critical for two reasons: you need it to correctly populate the 1099-NEC at year-end, and if you don't collect it and the contractor's information turns out to be incorrect, you may be required to perform "backup withholding" (24% of payments to the IRS) on future payments.
Store W-9 forms securely — they contain sensitive tax identification information. Keep them for at least four years after the last year you filed a 1099 for that contractor. Digital storage with encryption is recommended over physical copies.
Payment Methods
ACH Bank Transfer: The most common method for paying domestic contractors. Direct bank-to-bank transfers are fast (typically 1-3 business days), free or very low-cost through most business banking platforms, and create clean payment records. Contractors generally prefer this method for its reliability and zero fees on their end.
Wire Transfer: Appropriate for large payments or international contractors where ACH isn't available. Faster than ACH (often same-day) but involves fees on both ends ($15-$45 per wire domestically, more internationally). Use for payments over $10,000 or when same-day delivery is necessary.
Check: Declining in use but still common in some industries. Creates a physical paper trail. Main downsides: slow (mail + clearing time), can be lost or stolen, and requires both parties to have bank accounts. If you use checks, always send by a trackable method for amounts above $500.
PayPal / Venmo Business: Acceptable for smaller contractors, especially creatives. However, PayPal charges the recipient a processing fee (typically 2.89% + 49¢), so many contractors prefer bank transfer. PayPal also doesn't integrate well with most business accounting systems, creating reconciliation friction.
Contractor Payroll Platforms: Services like Gusto, Deel, or Remote specialize in contractor payment — they handle W-9 collection, store contracts, issue payments in multiple currencies, and generate 1099s automatically. For businesses with multiple contractors, these platforms significantly reduce administrative burden. See our payroll guide for a detailed comparison.
Tax Withholding Rules
The standard rule: no withholding for independent contractors. Pay the full invoiced amount. The contractor is responsible for their own income tax and self-employment tax.
Exception — Backup Withholding: If a contractor fails to provide a valid W-9, provides incorrect information (name/TIN mismatch), or the IRS notifies you that the contractor is subject to backup withholding, you must withhold 24% of payments and remit to the IRS. Backup withholding is uncommon but important to understand.
Exception — International Contractors: Payments to foreign contractors may be subject to withholding under Chapter 3 or Chapter 4 (FATCA) provisions, depending on the contractor's country of residence, the type of work performed, and whether a tax treaty applies. Foreign contractors should provide Form W-8BEN (individuals) or W-8BEN-E (entities) rather than a W-9. Consult a tax professional before making payments to international contractors.
1099-NEC Filing Requirements
Form 1099-NEC (Nonemployee Compensation) must be issued to any contractor you paid $600 or more during the calendar year for services. Note: this threshold applies per contractor, not per payment — multiple small payments that sum to $600+ trigger the requirement.
What triggers a 1099-NEC: Payments for services to an individual (sole proprietor) or partnership. Payments via check, cash, bank transfer, or invoice.
What does NOT trigger a 1099-NEC: Payments to corporations (C-corps and S-corps are generally exempt, with exceptions for attorneys and medical providers). Payments made via credit card or third-party payment networks (PayPal, Stripe) — these are reported by the payment processor on a 1099-K instead.
Deadlines: January 31 to both the contractor and the IRS. File electronically through FIRE (Filing Information Returns Electronically) if you're submitting 10 or more returns. For fewer, you can paper-file or use a 1099 filing service.
Failure to file 1099s carries penalties of $60–$310 per form, depending on how late the filing is, with a maximum annual penalty. For intentional disregard, the penalty is $630 per form with no annual maximum. The cost of compliance is far lower than the cost of non-compliance.
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International contractor payments involve additional complexity: currency conversion, international transfer fees, potential withholding tax obligations, and different documentation requirements.
For foreign contractors, collect Form W-8BEN (for individuals) or W-8BEN-E (for foreign entities) instead of a W-9. These forms certify the contractor's foreign status and claim treaty benefits if applicable. Retain these forms for at least three years after the last payment or three years after the form expires, whichever is later.
Payment methods for international contractors: international wire transfer (reliable but expensive), platforms like Wise (TransferWise) that offer competitive exchange rates and low fees, or global contractor payroll platforms (Deel, Remote, Papaya Global) that handle compliance, currency conversion, and local payment requirements automatically. For a full breakdown of international payment options, see our dedicated guide.
Avoiding Misclassification
Misclassifying an employee as an independent contractor is one of the most common and costly business compliance errors. If the IRS determines you've misclassified workers, you can owe back payroll taxes, employer FICA contributions, penalties, and interest — potentially for every affected worker going back years.
The IRS uses a three-category test (Behavioral Control, Financial Control, and Type of Relationship) to evaluate classification. Key factors that indicate an employment relationship (not contracting): you control how and when the work is done, not just the result; the worker works exclusively or primarily for you; you provide tools and equipment; the relationship is indefinite rather than project-based; the worker has no opportunity for profit or loss.
Red flags that you may have employees, not contractors: the contractor works a regular schedule at your office, you direct their daily activities in detail, they can't work for others while working for you, or you've hired them for years with no defined project end date. When in doubt, classify as an employee or consult an employment attorney before proceeding as a contractor relationship. Using a proper contractor agreement that correctly defines the relationship is essential but not sufficient on its own — the actual working arrangement must match the contract.