How to Pay Independent Contractors: 6 Payment Methods + Tax Forms

You hired a graphic designer to redo your menu. They did great work, sent you an invoice, and now you're stuck wondering: do I just Venmo them? Mail a check? What about taxes? Figuring out how to pay independent contractors shouldn't feel like navigating a legal minefield, but here you are Googling at 11 PM because you don't want to mess this up.

Here's the thing—paying contractors is simpler than payroll, but it comes with its own rules. Send money the wrong way or skip the right tax form, and you're looking at IRS penalties that start at $50 per mistake and climb fast. 

This guide walks you through 6 payment methods that actually work for small businesses, the tax forms you can't skip, and how to avoid the expensive mistakes that trip up first-time business owners.

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TL;DR: How to pay contractors for small business

Need to pay a contractor quickly and legally? Here's what you need to know:

1. Get your EIN and collect Form W-9 from your contractor before starting work
2. Negotiate payment terms (hourly vs. per-job) and put everything in writing with a detailed contract
3. Issue Form 1099-NEC by January 31 if you paid them more than $600 during the year
4. Don't withhold taxes from contractor payments (unlike employees, they handle their own taxes)
5. Choose your payment method from cash, check, direct deposit, or payroll software
6. Keep detailed records of all payments for tax reporting and backup withholding compliance

For complete legal requirements and compliance tips, read the full guide below.

Before You Send Any Money: Required Setup

Before you pay an independent contractor, these documents protect both you and your business from compliance issues and payment disputes.

Get Your Employer Identification Number (EIN) (If You Don't Have One)

Your EIN is essentially your business's Social Security number. While sole proprietors without employees can use their Social Security number for contractor payments, getting an EIN offers important benefits: it protects your personal SSN from identity theft, looks more professional to contractors, and makes opening business bank accounts easier.

Apply online at the IRS EIN application site—the process takes about 15 minutes, and you'll receive your 9-digit number immediately. It's free, and you can start using it right away for contractor payments and 1099 filings.

Collect Form W-9 From Every Contractor

Form W-9 provides the contractor's legal name, business name, address, and Social Security number or EIN. Collect it before you send the first payment, not when you're scrambling at year-end to file 1099s.

The W-9 stays in your records—you don't file it with the IRS. You'll use the information on it to complete the contractor's 1099-NEC form in January. Make it your policy: No W-9 means no payment.

Create a Simple Contract or Agreement

A written agreement prevents misunderstandings about payment terms, project scope, and deadlines. Your contractor agreement should include payment terms (hourly rate or project fee), payment schedule (upon completion, Net-30, etc.), project deadlines, and what happens if either party doesn't fulfill their obligations.

While contractor agreements differ from traditional employment contracts, both serve to clarify expectations and protect all parties involved.

6 Ways to Pay Independent Contractors

Most small businesses use a combination of these methods depending on the contractor and project. The key is maintaining clear records regardless of which payment method you choose.

1. Direct Deposit (Fastest and Most Professional)

Direct deposit transfers money electronically from your business bank account directly into the contractor's account using ACH transfers.

Pros: Fast (1-2 days), professional appearance, automatic digital record-keeping, no risk of lost checks.

Cons: Requires banking information, your bank may charge $0-3 per transaction.

When to use: Regular contractors you work with frequently, anyone requesting direct deposit, when you need guaranteed delivery dates.

2. Paper Checks (Traditional but Still Common)

Write a check, hand it to the contractor or mail it, and they deposit it at their bank. Keep a copy or photo of every check you write to contractors.

Pros: No technology required, familiar to all contractors, creates a paper trail through bank statements.

Cons: Slow, checks can get lost, requires manual record-keeping.

When to use: One-time contractors for small projects, contractors who prefer traditional payment methods.

3. Cash Payments (Legal but Risky)

Cash payments to independent contractors are completely legal, but they come with significant record-keeping requirements.

Critical warning: You MUST keep detailed written records of every cash payment. Get a signed receipt showing the date, payment amount, services provided, and both signatures.

Why it's risky: No automatic paper trail, IRS scrutinizes large cash payments, you can't prove the expense without receipts if audited.

Better alternative: Pay with a money order instead. It costs $1-2 but creates an official record that satisfies IRS requirements.

4. PayPal, Venmo, or Digital Payment Apps

Digital payment apps offer instant transfers with built-in record-keeping.

Pros: Instant payment delivery, extremely convenient, automatic digital records, works great for remote contractors.

Cons: Transaction fees of 2.9% + $0.30 for PayPal business payments, may appear less professional.

When to use: Small payments under $500, remote contractors, quick turnaround situations.

Important: Use business accounts, not personal accounts, for proper documentation. PayPal and similar services report annual payment totals to the IRS.

5. Credit Card Payments

Some contractors accept credit card payments when they have invoicing software that processes card payments.

Pros: Earn rewards points, 30-day payment float helps cash flow, excellent automatic record-keeping.

Cons: Contractor may add a 3% processing fee, not all contractors accept cards.

When to use: Large one-time projects where rewards points offset processing fees.

6. Payroll Software (Easiest for Compliance)

Payroll software handles both employee and contractor payments in one system, automatically tracking annual totals toward the $600 1099 threshold.

Pros: Automatic 1099-NEC generation in January, tracks the $600 threshold, stores W-9s digitally, integrates with accounting software, maintains compliant records for audits.

Cons: Monthly software subscription cost (typically $40-150 per month).

When to use: You work with 3 or more contractors regularly, you're paying contractors monthly or more frequently, you want to avoid year-end tax form stress, you also have employees. 

Ultimately, choosing the best payroll software for small business depends on your specific needs, team size, and budget.

Setting Payment Terms and Schedules

Payment terms should be negotiated before work begins and documented in your contractor agreement. Clear expectations prevent disputes and damaged relationships. The two main decisions you'll make are how to structure payment (hourly vs. project-based) and when payment is due (immediately, Net-30, milestone-based, etc.).

Hourly vs. Project-Based Payment

Both payment structures are legal and common for independent contractors. Choose based on the project type and how you prefer to manage costs.

Hourly payment: Better for ongoing work where scope isn't fully defined. Requires the contractor to track hours and submit detailed invoices.

Project-based payment: Better for defined deliverables with clear completion criteria. Simpler invoicing—contractor submits one invoice when complete.

Hybrid approach: Set an hourly rate with a project cap, like "$75/hour not to exceed $3,000 total."

Common Payment Schedules

Understanding standard payment schedules helps you negotiate terms that work for both your business and the contractor. The right schedule depends on project size, cash flow, and industry norms.

Upon completion: Most common for small projects under $2,000. Contractor finishes work, submits invoice, you pay within 7-14 days.

Net-30 or Net-60: Standard for business-to-business contracts. Payment is due 30 or 60 days after invoice date.

Milestone-based: For large projects broken into phases. Example: 25% on kickoff, 25% at design approval, 50% on completion.

Deposit plus completion: Common in construction and creative industries. 50% upfront, 50% when finished.

Put everything in writing before work begins. Consider managing your business cash flow when setting terms—don't promise Net-15 payments if your customers pay you on Net-60 terms.

Tax Forms and Compliance

Independent contractor tax compliance is simpler than employee payroll, but the penalties for mistakes are just as severe. The IRS requires specific forms at specific times—miss a deadline or file incorrect information, and you're looking at penalties that start at $60 per form and climb fast. Here's what you need to know to stay compliant without the headache.

Form W-9 (Before You Pay)

Collect the W-9 before you send the first payment—not three months later when you suddenly remember you need it. The contractor fills it out with their current legal name and correct Social Security number or EIN. You keep W-9s in your records for at least four years. You never file them with the IRS—they're just for your files so you can complete their 1099 at year-end.

If you're unsure about the process, learn how to fill out a W-9 correctly to avoid issues.

Form 1099-NEC (After You Pay)

Form 1099-NEC reports payments to independent contractors. If you paid a contractor $600 or more during the calendar year (or $2,000+ starting in 2026), you must file this form.

Key deadlines: Forms are due February 2, 2026 for the 2025 tax year (the standard deadline is January 31, but it moves to the next business day when that falls on a weekend). You send Copy B to the contractor and Copy A to the IRS—both by the same date.

Important: The 1099-NEC replaced the 1099-MISC for contractor payments starting in 2020. If you see old articles mentioning 1099-MISC for contractors, that information is outdated. For a detailed comparison, review our guide on understanding 1099 employees versus W-2 workers.

Penalties for late or missing 1099s:

• $60 per form if filed within 30 days of the deadline
• $130 per form if filed after 30 days but by August 1
• $330 per form if filed after August 1 or not filed at all
• $660 per form (with no maximum) for intentional disregard

How to file: Buy paper forms from office supply stores and mail them, use the IRS FIRE or IRIS system for free electronic filing, or let your payroll software generate and file them automatically. If you're filing 10 or more 1099s, electronic filing is required.

Do Contractors Get Pay Stubs?

No. Independent contractors don't receive traditional pay stubs like employees because they're self-employed business owners who track their own income for quarterly estimated taxes.

What contractors get instead: Copies of invoices they submitted to you, payment confirmations (bank deposits, cleared checks, PayPal receipts), and Form 1099-NEC at year-end showing their total payments from you.

What they use for proof of income: Bank statements showing your deposits, the 1099-NEC form you send in January, and copies of their own invoices. Some payroll systems generate "payment summaries" when you pay contractors, but these aren't pay stubs in the legal sense—just confirmation that payment is processed.

Backup Withholding (The Exception)

You normally don't withhold any taxes from contractor payments—they receive the full amount and handle taxes themselves. There's one important exception: backup withholding.

Backup withholding happens when the IRS notifies you that a contractor's taxpayer identification number is incorrect or missing. They'll send you an official notice requiring you to withhold taxes from future payments to that contractor.

The backup withholding rate is 24% of the gross payment amount. For a $1,000 payment, you'd withhold $240 and send the contractor $760. You file backup withholding using Form 945, which is due January 31 for taxes withheld during the previous calendar year.

If you receive a backup withholding notice from the IRS, follow every instruction exactly as directed. Contact the contractor immediately to resolve the issue—usually it's a simple mismatch between the name on their W-9 and what the IRS has on file.

Common Payment Mistakes to Avoid

These mistakes cost small businesses thousands in penalties, damaged relationships, and wasted time. The good news? They're all preventable. Most contractor payment problems stem from poor record-keeping, missed deadlines, or confusion about worker classification. Learn from others' expensive lessons so you don't have to repeat them.

Paying Without a W-9

Fast forward to January: you need to file their 1099-NEC, but you never collected their W-9. The contractor isn't responding, and you're facing penalties starting at $60 per form.

Solution: No W-9 means no payment. Make this your firm policy from day one. Most professional contractors will send you a W-9 with their first invoice since they know you'll need it.

Forgetting to Track the $600 Threshold

Small payments throughout the year add up quickly. You pay a contractor $200 in March, $150 in July, and $400 in November. You never intended to hit $600, so you didn't track the total. Surprise—that's $750, and you owe them a 1099-NEC. Missing a required 1099 filing means IRS penalties starting at $60 per form, increasing to $330 if you never file.

Solution: Use payroll software that automatically tracks annual totals per contractor, or set a reminder to review contractor payment totals in early December so you have time to collect missing W-9s before the February 2 deadline.

Mixing Contractor and Employee Payments

Worker misclassification is one of the IRS's top enforcement priorities, making it critical to understand independent contractor laws. Picture this: you hire someone as a contractor, but over time the relationship starts looking more like employment—they work set hours in your location, use your equipment, and follow your processes. 

If the IRS determines someone should have been an employee, you owe back payroll taxes (including the employer's 7.65% share of Social Security and Medicare), penalties, and potentially unemployment insurance. We're talking thousands of dollars per misclassified worker.

Solution: Keep contractor and employee payments in completely separate systems. If a working relationship is evolving from contractor to employee, make the official change sooner rather than later. Consult an employment attorney or HR professional if you're unsure about classification.

Paying Late Without Communication

You promised Net-30 payment terms. Day 35 arrives, no payment, no explanation. The contractor sends a polite follow-up email. Day 45, still nothing. Now you've damaged a relationship with someone who does excellent work.

Contractors are small business owners too, often relying on timely payments to cover their own expenses. Late payments without explanation are unprofessional and burn bridges with talented people you might need again.

Solution: If payment will be late, communicate proactively before the due date. A simple "We had an unexpected cash flow issue, but your payment will arrive by Friday" goes a long way. Most contractors understand occasional delays if you're honest and follow through.

No Paper Trail for Cash Payments

You pay a contractor $800 in cash for a rush project. They do great work. You plan to write yourself a receipt later. Three months pass. Tax time arrives. You have no documentation of the payment.

Without a signed receipt, the IRS may disallow the business expense deduction, and you can't prove you paid the contractor the amount you claim on their 1099-NEC.

Solution: If you must pay cash, get a signed receipt immediately—before the contractor walks away. Include the date, payment amount, what services the payment covers, and both signatures. Pre-printed receipt books from office supply stores work perfectly for this.

State-Specific Considerations

While federal rules for paying contractors are consistent nationwide, some states have additional requirements you need to know about. State-level regulations focus primarily on worker classification rules and state tax reporting—both areas where violations can trigger expensive audits.

California uses the ABC test, which makes it significantly harder to classify workers as contractors rather than employees. If you're hiring contractors in California, review the state's classification rules carefully or consult an employment attorney.

New York requires written contracts for contractors in certain industries, particularly construction and entertainment. Verbal agreements aren't sufficient for legal protection.

New Jersey has strict worker classification rules similar to California's. The state presumes workers are employees unless you can prove otherwise using their multi-factor test.

State tax reporting: Some states require their own version of 1099 forms in addition to federal forms. Check your state tax authority's website or ask your accountant about state-specific contractor reporting requirements.

Before hiring contractors in multiple states, check your state labor department website for specific requirements. Employment laws vary significantly by state, and what's acceptable in Texas might violate regulations in Massachusetts.

When in doubt, consult with a CPA familiar with your state's rules or an employment attorney who specializes in contractor relationships. The consultation fee is much cheaper than the penalties for violations.

Once you understand your state's requirements, the actual payment process remains the same regardless of location. Direct deposit works the same in Alaska as it does in Florida.

How Homebase Handles Contractor Payments

Homebase Payroll lets you pay both employees and contractors from one platform. When you pay a contractor, we track it against their annual total automatically. Approaching $600? We remind you. January arrives? We generate their 1099-NEC using the W-9 they submitted when you added them.

If you're new to payroll systems, start with our guide on setting up payroll for your business.

Homebase works especially well if you:

• Work with 3+ contractors throughout the year
• Pay contractors monthly or more frequently
• Already use Homebase for scheduling or time tracking
• Have both employees and contractors on your team

Learn more about Homebase Payroll

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Frequently Asked Questions About Paying Independent Contractors

How do I pay someone on a 1099?

You don't pay someone "on a 1099"—a 1099 is a tax form, not a payment method. Here's the actual process: collect their W-9 form first, pay them using any method you choose (direct deposit, check, PayPal, cash), track your total payments to them during the calendar year, and if you paid them $600 or more, send them a 1099-NEC by February 2. 

The 1099 documents the payment for tax purposes; it's not how you send the money. For a step-by-step walkthrough of your first contractor payment, check out our detailed guide on how to pay your first contractor.

Can I pay a contractor with a salary?

No, you cannot pay a contractor with a salary. Salary implies an employment relationship, not contractor status. Contractors are paid either hourly rates for time worked, fixed fees for completed projects, or milestone payments based on deliverables. 

If you want to pay someone a regular salary with benefits and tax withholding, they need to be classified as an employee, not an independent contractor.

What's the difference between paying a 1099 worker and a W-2 employee?

The difference between paying a 1099 worker and a W-2 employee comes down to taxes and benefits. With 1099 contractors, you don't withhold any taxes—they receive full payment and handle their own quarterly taxes. 

With W-2 employees, you withhold income tax, Social Security, and Medicare from every paycheck, pay the employer portion of payroll taxes (7.65%), and may provide benefits. Contractors get 1099-NEC at year-end; employees get W-2.

How do independent contractors get paid?

Independent contractors get paid by submitting an invoice for completed work, waiting for payment based on agreed terms (Net-30, upon completion, etc.), and receiving payment via their preferred method—direct deposit, check, PayPal, or other options. 

Unlike employees with regular paychecks, contractors control when they invoice and what payment methods they accept. If you paid them $600 or more during the year, they'll receive a 1099-NEC in January.

Do I need special software to pay contractors?

You don't need special software to pay contractors—you can handle payments manually with checks or direct deposits through your bank. However, software makes contractor payments dramatically easier if you pay multiple contractors, also have employees, want automatic 1099 generation in January, or need better record-keeping. 

The tipping point is usually around 3-5 contractors. Below that, manual tracking is manageable; above that, software prevents expensive mistakes.

Can I pay contractors the same day as employees?

Yes, you can pay contractors the same day as employees if you use payroll software that handles both worker types. This lets you run payroll once instead of separately, track all labor costs in one system, and simplify accounting. 

Just ensure your payroll system properly categorizes each worker—employees and contractors require completely different tax treatment even if paid on the same day.

What happens if I forget to send a 1099?

If you forget to send a 1099, IRS penalties start at $60 per form if filed within 30 days of the deadline, increase to $130 per form if filed by August 1, and jump to $330 per form if filed after August 1 or not at all. File as soon as you realize the mistake—the penalty increases the longer you wait. For intentional disregard, penalties reach $660 per form with no maximum.