Whether you hire a contractor or an employee, you’ve got to pay for the work they complete correctly. While actually making a payment might be just a matter of writing a check or swiping a card, you also need to make sure that you do everything necessary to keep the IRS happy — our government friends want to know what companies and contractors you issue payments to so that they can get their fair share.
Luckily, it’s not too tough to correctly report the money you pay to contractors. Compared to all the financial stuff that goes along with paying employees — think payroll taxes and the like — working with contractors is a breeze.
Paying your contractors
One of the first questions you’ll need to answer when hiring a new contractor is how you will pay them. After all, everyone wants to know what the financial situation looks like when they’re working. You might also find that certain freelancers or contractors will only accept payment in certain ways — such choices aren’t meant to hamper your ability to work together but rather to ensure that everyone’s interests are protected.
In general, your payment options are divided between paper and electronic: you can write a check or send a payment online. Even the smallest of businesses can now accept credit card payments relatively easily (PayPal® and other online processors offer a variety of credit card and debit card options). It’s more a question of what makes sense for your accounting and what options the contractor in question will accept.
No matter what payment method you agree on with the freelancers you hire, make sure payment terms are spelled out in the contract that you both sign.
In addition to describing how you will be sending payment, you should also include payment dates, any invoicing requirements you have, and any other factors that impact your ability to actually mail a check or submit an electronic payment. Do your best to minimize any possibility of misunderstandings — it’s much easier to sort through a communication mistake than it is to resolve a payment problem, especially when a contractor is counting on a payment to come through.
Handling tax reporting
The easiest option for dealing with the paperwork that goes along with paying contractors is to let someone else deal with it. Traditionally, this has meant working with a CPA who will handle the process of completing and mailing forms for both your contractors and the IRS. However, technology has created some new options.
Because of the way PayPal and many online marketplaces are structured, they have a responsibility to report any payments made through their systems to the IRS (at least for U.S.-based recipients). Their obligations actually let you off the hook, because the IRS doesn’t want you to double-report the money you paid to contractors. You’ll still want to check that the numbers are correct and that your contractors receive the appropriate paperwork — trusting anyone blindly with your taxes is a bad idea — but as long as you can issue payments through such a system, you’ll have fewer reporting obligations.
However, make sure that your contractors are willing to accept payments through such systems before starting on any new project. Because most of these systems (including PayPal) can take a sizable chunk of any payment they pass along, many contractors are reluctant to use them or will require an additional fee to accept payments through those systems.
If you only work with a few contractors over the course of the year and neither a CPA nor a marketplace fit your plans, you can handle the reporting yourself: you can purchase packs of 1099-MISC forms from office supply stores and fill them out either by hand or print them using specialized software.
Keeping on the straight and narrow
Dealing with the IRS can be a little discomforting. If something goes wrong with your tax reporting, that particular organization isn’t known for their forgiveness or sympathy. But you shouldn’t be scared of working with contractors: the IRS tries to keep the reporting process manageable. You aren’t even required to start reporting payments to a given contractor until you’ve paid out at least $600 in a year. Those numbers mean that you don’t even need to worry about small projects.
But you do want to make sure that you’re keeping your records correctly, even for those amounts that are too small to report. In the event of an audit, the IRS can look at every part of your business. Because payments to contractors can be abused, the IRS will look closely at such transactions during an audit.
Stick to the straight and narrow on your taxes.
Of course, it’s a good idea to consult with a tax professional about your specific business, even if you plan to handle reporting payments to the IRS on your own. There are often opportunities to improve your tax situation when dealing with contractors and you don’t want to run the risk of missing such an opportunity. Even a short meeting could pay off.
This article is not intended as legal or tax advice. If you have questions, please contact your legal or tax professional.