Date Modified: September 17, 2026
Paying independent contractors is different from paying employees because businesses typically do not withhold income taxes or payroll taxes from contractor payments. Instead, employers must properly classify workers, collect tax information, track payments and issue Form 1099-NEC when required. The Form 1099-NEC federal reporting threshold increased from $600 to $2,000 for payments made in tax year 2026 under the One Big Beautiful Bill Act.
Payroll software can simplify contractor payments by helping businesses pay workers, maintain accurate records, track payment history and prepare required tax forms, all while keeping contractor and employee payments organized and separate.
Key takeaways
- 1099 payroll refers to the payment and management of independent contractors. In most cases, contractors are responsible for paying their own income and self-employment taxes, while businesses typically do not withhold payroll taxes from those payments.
- Worker classification is critical. Employers should determine whether a worker is properly classified as an employee or independent contractor before establishing the payment process.
- Businesses should generally collect Form W-9 before paying an independent contractor so they have the taxpayer information needed for reporting.
- Form 1099-NEC is commonly used to report nonemployee compensation when applicable IRS reporting thresholds are met.
- Payroll or contractor payment software can simplify payment tracking, recordkeeping and year-end tax reporting.
What is 1099 payroll?
1099 payroll is a common term for paying and tracking independent contractors who may receive a Form 1099-NEC. Unlike employee payroll, businesses generally do not withhold federal income, Social Security or Medicare taxes from payments made to properly classified independent contractors.
Instead, businesses typically collect a Form W-9, pay contractors according to agreed-upon terms, maintain accurate payment records and issue Form 1099-NEC when required.
Managing independent contractor payroll
Paying independent contractors usually involves fewer tax responsibilities than paying employees, but businesses must still correctly classify workers, track payments and comply with required tax reporting rules. These savings in time and cost are not without risks though. The potential pitfall when paying independent contractors lies in worker classification.
According to ADP Research Institute data cited by WorkMarket, one in six enterprise workers is a gig worker, and about 40% of enterprises have workforces where one in four workers is a gig worker. As organizations engage more independent contractors alongside employees, consistent worker-classification practices become increasingly important.
How do you determine whether a worker is an employee or independent contractor?
Companies must thoroughly understand the relationship between themselves and their workers – are they employees or independent contractors? The answer isn’t always cut and dried, which is why the IRS provides specific guidelines for worker classification.
In general, if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done, then the person performing the work is an independent contractor. To determine this degree of control, the IRS considers three common law rules:
- Behavioral – Assesses whether the organization controls or has the right to control what the worker does and how it’s done
- Financial – Evaluates whether the business has the right to direct or control the financial aspects of the worker’s job, such as how the individual is paid, whether expenses are reimbursed, who provides tools and supplies, etc.
- Type of relationship – Looks at how the organization and worker perceive their relationship and considers evidence, such as written contracts or employee-type benefits, which would indicate if the relationship will continue or if the work performed is a key aspect of the business
Companies must weigh all three factors when classifying workers. Some common law rules may show that a worker is an employee and others may demonstrate that the individual is an independent contractor. Additionally, factors that are applicable in one situation may not be relevant in another. Organizations that have difficulty reaching a conclusion can file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding with the IRS.
Independent contractor vs. employee payroll
Once a worker is properly classified, businesses should understand how payroll and tax responsibilities differ for independent contractors and employees.
| Payroll consideration | Independent contractor | Employee |
|---|---|---|
| Federal income tax withholding | Generally not withheld | Employer generally withholds |
| Social Security and Medicare | Contractor generally pays self-employment tax | Employer and employee generally share FICA obligations |
| Tax information form collected | Form W-9 | Form W-4 |
| Year-end tax form | Form 1099-NEC, when applicable | Form W-2 |
| Payment method | Hourly, project, milestone or other contract terms | Salary, hourly wages or other employee compensation |
| Benefits | Generally not employee benefits | May be eligible for employer-sponsored benefits |
| Overtime rules | Generally not covered as employees under FLSA overtime rules | Nonexempt employees may be entitled to overtime |
Other classification guidelines
The IRS isn’t the only authority on independent contractor payroll. Other federal agencies, such as the Department of Labor, and individual state governments have their own rules regarding worker classification, which in some cases, may lead to a different conclusion than the IRS. Given the risks involved, organizations are strongly advised to consult legal counsel on these issues.
Tax penalties for incorrect classification
The IRS strictly enforces worker classification status. Businesses that misclassify an employee as an independent contractor, even if unintentionally, may face serious repercussions, including taxes and penalties. They may also have to reimburse misclassified workers for unpaid overtime in accordance with the Fair Labor Standards Act (FLSA).
Paying workers
Classification statuses will largely determine the process by which workers are compensated. When paying employees, employers are responsible for deducting income taxes, FICA taxes and other applicable taxes from their pay, as well as any voluntary benefit contributions and court-ordered garnishments. Some of these deductions, along with the employer’s payments to unemployment tax and FICA, are then filed with government agencies at specified deadlines. This process is largely inapplicable when paying independent contractors, but there are other variables to consider.
Paying independent contractors
Independent contractors may be paid hourly, by project, by milestone or under another agreed compensation structure documented in a contract or statement of work. Where project-based work is concerned, freelancers may request an upfront deposit, followed by milestone payments. It is best practice to have a signed contract or a statement of work (SOW) that documents the terms of payment, timelines and project deliverables.
In addition to payment schedule, payment type is important when vying for the services of an independent contractor. Many today expect fast access to their earnings and may balk at the idea of receiving a check in the mail. Digital payments and prepaid pay cards are often the preferred choice of technology-savvy freelancers who may not have traditional bank accounts.
Independent contractors are playing a growing role in today's workforce. Research from WorkMarket by ADP® found that 71% of surveyed small businesses plan to increase their use of independent contractors, while 86% of surveyed companies expect to increase contractor hiring and utilization to access specialized skills and workforce flexibility.
How is an independent contractor paid?
Once a worker is properly classified, businesses can generally follow four steps to establish the contractor payment and reporting process. Every situation is different, but the general steps are as follows:
- Obtain the independent contractor’s Form W-9, Request for Taxpayer Identification Number and Certification
Taxpayer identification numbers (TINs) are needed to report payments made to the independent contractors. - Provide compensation for work performed
Pay the freelancer according to the schedule and method agreed upon in the contract or SOW. - Remit backup withholding payments to the IRS, if necessary
If an organization receives a backup withholding notice from the IRS, it must begin deducting a 24% tax from any future payments to an independent contractor. - Complete Form 1099-NEC, Nonemployee Compensation
Businesses that pay more than $600 per year to an independent contractor must complete Form 1099-NEC and provide copies to both the IRS and the freelancer by the specified annual deadline.
Who is responsible for the independent contractor's federal payroll taxes?
Independent contractors generally pay their own federal income taxes and self-employment taxes rather than having those taxes withheld from their payments by the business that hired them. This is a two-part tax, with 12.4% going to Social Security and 2.9% going to Medicare, for a total of 15.3%. Payments are usually filed quarterly using Form 1040-ES, Estimated Tax for Individuals. Freelancers may also have to pay state and local tax, depending on the jurisdiction.
As mentioned previously, however, there are some instances where a service recipient is required to deduct taxes from an independent contractor’s pay. Backup withholding typically occurs when freelancers provide the wrong TIN or incorrectly report their income on a tax return.
What is Form 1099-NEC?
Form 1099 is a tax information return that reports income received outside of wages, salaries and tips. There are three different versions, each with different purposes:
- Form 1099-NEC – reports how much a business paid annually to nonemployees, including independent contractors
- Form 1099-MISC – reports a business’s miscellaneous payments (e.g. rents paid to property managers)
- Form 1099-K – reports payment card transactions through third-party networks
How is Form 1099-NEC completed?
Companies that need to report compensation paid to independent contractors generally follow these steps:
- Obtain a copy of Form 1099-NEC from the IRS or a payroll service provider
- Provide the name and address of both the payer and the recipient
- Calculate the total compensation paid
- Note the amount of taxes withheld if backup withholding applied
- Send copies of the form to the IRS and the independent contractor by January 31 of the following tax year
Benefits of paying independent contractors through a payroll system
Businesses may pay contractors through accounts payable, contractor management software or a payroll platform that supports nonemployee payments. Using one system to manage both employee payroll and contractor payments can make recordkeeping and year-end reporting easier. The benefits of doing so include:
Quick, automatic payments
Payroll software can usually accommodate direct deposit and paycards so that freelancers receive the fast payments they crave.
Accurate payroll records
Integrating employee payments with independent contractor transactions allows all payroll data to be saved in one place.
Automatically generate Forms 1099-NEC and 1099-MISC
Payroll software provides easy access to all the forms necessary when paying freelancers.
Comprehensive reporting
Organizations can run reports to see how much they’ve paid independent contractors year to date.
What information do you need to pay an independent contractor?
Before paying an independent contractor, businesses should generally collect the information needed to identify the worker, document the engagement and support tax reporting. This may include:
- Completed Form W-9
- Legal name or business name
- Taxpayer identification number
- Mailing address
- Payment terms
- Contract or statement of work
- Payment method
- Records of amounts paid
Frequently asked questions about independent contractor payroll
Are independent contractors considered a payroll expense?
Because organizations generally don’t have to deduct taxes from payments made to independent contractors, they may consider them a business expense rather than a payroll expense. However, those that are already using payroll software to pay employees may find it more convenient to compensate freelancers from the same system.
Can you pay an independent contractor hourly?
Yes, one of the most common ways of compensating independent contractors is with hourly pay. In some instances, this is done via a retainer, wherein a lump sum is paid at the start of every month for a certain number of hours. Companies also have the option of paying freelancers on a project basis.
Can an independent contractor be paid a salary?
Workers who receive a regularly paid wage, such as a salary, are more likely to be considered employees, not independent contractors. In fact, method of payment is one of the key financial criteria that the IRS looks at when determining worker classification.
Is it illegal to treat an employee as an independent contractor?
Yes, businesses that misclassify an employee as an independent contractor can be penalized by the IRS, other federal agencies, and state and local jurisdictions, where applicable. They also may have to compensate misclassified workers for any unpaid overtime that should have been received during the period of the misclassification.
How many hours can a 1099 independent contractor work?
There is generally no set limit on how many hours a 1099 independent contractor can work. Unlike employees, independent contractors are typically paid according to the terms of a contract rather than based on employee work schedules. However, businesses should ensure workers are properly classified, as worker classification depends on multiple factors beyond the number of hours worked.
How do independent contractors do payroll?
Independent contractors generally report their earnings to the IRS quarterly using Form 1040-ES, Estimated Tax for Individuals. This covers both their federal income tax and self-employment tax liabilities. They may also have to pay state and local taxes according to their state and local government guidelines.
Do businesses withhold taxes from independent contractor payments?
Generally, no. Businesses typically do not withhold federal income tax, Social Security tax or Medicare tax from payments made to properly classified independent contractors. Instead, independent contractors are usually responsible for paying their own taxes.
How do independent contractors pay taxes?
Independent contractors are generally responsible for paying their own federal, state and local taxes. Many make estimated tax payments throughout the year and report their income when filing their tax returns.
Do I need a W-9 before paying an independent contractor?
Businesses should generally collect a completed Form W-9 before paying an independent contractor. The form provides important tax information, including the contractor's taxpayer identification number (TIN), which may be needed for tax reporting purposes.
Can payroll software pay independent contractors?
Yes. Many payroll software solutions allow businesses to pay independent contractors, track payment history, maintain records and prepare required tax forms, such as Form 1099-NEC.
What is the difference between a 1099 contractor and a W-2 employee?
A 1099 contractor is an independent worker who typically manages their own taxes and benefits. A W-2 employee works for an employer, who generally withholds taxes from wages and may provide benefits such as health insurance, paid time off or retirement plans.
When does a business need to issue Form 1099-NEC?
A business generally needs to issue Form 1099-NEC when it pays an independent contractor $600 or more during the year for services performed in the course of business, unless an exception applies. Businesses should consult current IRS guidance to determine their specific reporting requirements.
This guide is intended to be used as a starting point in analyzing an organization’s payroll obligations and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.
Tax figures provided are as of the 2021 tax year.
