You don’t actually run payroll for 1099 workers, because they aren’t employees. Independent contractors handle their own taxes, and your obligations are simpler but different from traditional payroll. Instead of withholding taxes and running pay through a payroll system, you pay contractors directly for their work and report those payments to the IRS at year-end using Form 1099-NEC. The process has fewer steps than W-2 payroll, but getting it wrong can trigger penalties or force you to reclassify workers and pay back taxes.
Why 1099 Workers Don’t Go Through Payroll
Traditional payroll exists to calculate and withhold federal income tax, Social Security tax, and Medicare tax from each paycheck, then remit those amounts to the IRS on the employee’s behalf. With independent contractors, none of that applies. You don’t withhold any taxes. You don’t pay the employer share of Social Security or Medicare. You don’t contribute to unemployment insurance for them. The contractor is responsible for paying their own income taxes and self-employment taxes directly to the IRS, typically through quarterly estimated payments.
This distinction saves you money (the employer share of payroll taxes alone runs 7.65% of wages), but it only applies if the worker genuinely qualifies as an independent contractor. Calling someone a “1099 employee” is a contradiction in terms, and the IRS looks past labels to examine the actual working relationship.
Make Sure the Worker Is Actually a Contractor
The IRS uses three categories of evidence to decide whether someone is an employee or a contractor: behavioral control, financial control, and the type of relationship.
- Behavioral control: Do you control what the worker does and how they do it? If you dictate their hours, train them on methods, or supervise the process rather than just the result, that points toward employment.
- Financial control: Does the worker have their own business expenses, use their own tools, market their services to other clients, and have the opportunity for profit or loss? Contractors typically operate more like independent businesses.
- Type of relationship: Is there a written contract? Do you provide benefits like health insurance, vacation pay, or a pension? Is the work a core, ongoing part of your business, or a defined project?
No single factor is decisive. The IRS weighs the full picture, and the substance of the relationship governs, not how you label it in a contract. If you misclassify an employee as a contractor, you can be held liable for unpaid employment taxes, penalties, and interest. If you’re uncertain about a specific worker, you can file Form SS-8 with the IRS and request a formal determination.
Collect a W-9 Before Any Payment
Before you pay a contractor for the first time, have them complete Form W-9 (Request for Taxpayer Identification Number and Certification). This form gives you the contractor’s legal name, business name if applicable, address, and taxpayer identification number (either a Social Security number or an Employer Identification Number). You need this information to report payments accurately on the 1099-NEC at year-end.
Keep the completed W-9 in your files. You don’t send it to the IRS, but you’ll reference it when preparing 1099 forms. If a contractor refuses to provide a W-9, IRS rules require you to begin backup withholding at 24% from their payments until they comply.
How to Pay Contractors
You can pay contractors by check, direct deposit, wire transfer, or through a payment platform. There’s no required pay schedule the way there is with employees. Most businesses pay contractors on a schedule defined in their contract: upon invoice, biweekly, at project milestones, or on completion. The key rules are straightforward.
Pay the full agreed amount with no deductions. Don’t withhold federal or state income tax. Don’t withhold Social Security or Medicare. Don’t deduct anything for benefits. The contractor receives the gross amount and handles taxes on their own.
Keep clear records of every payment: the date, amount, method, and what the payment covered. You’ll need these records both for your own tax deductions (contractor payments are generally a deductible business expense) and for accurate 1099 reporting.
Written Agreements Protect Both Sides
A contract isn’t legally required to pay a contractor, but it’s practically essential. A good independent contractor agreement should cover the scope of work, deliverables, payment terms and rates, who owns the finished work product, and the expected timeline. It should also specify that the worker is an independent contractor responsible for their own taxes.
The contract alone won’t shield you from misclassification claims if the actual working relationship looks like employment, but it establishes expectations and provides documentation if questions arise later.
Filing Form 1099-NEC
If you pay a contractor $600 or more during the calendar year, you must file Form 1099-NEC (Nonemployee Compensation) reporting the total amount paid. You send one copy to the contractor and file another with the IRS. Both are due by January 31 of the following year. For payments made during 2025, for example, the 1099-NEC is due January 31, 2026, to both the contractor and the IRS.
If you file 10 or more information returns in a year (counting all types, including W-2s and various 1099 forms combined), the IRS requires you to file electronically. You can e-file for free through the IRS Information Returns Intake System (IRIS). Businesses with fewer than 10 returns can still file on paper, though electronic filing is faster and reduces errors.
Payments made through third-party platforms like PayPal or credit card processors may be reported on Form 1099-K by the payment processor instead. In that case, you generally don’t need to issue a 1099-NEC for the same payments, but keeping detailed records helps you confirm nothing falls through the cracks.
Penalties for Late or Missing 1099s
Filing 1099-NEC forms late triggers penalties that escalate the longer you wait. Penalties range from $60 per form if you file within 30 days of the deadline to $310 per form if you file after August 1 or don’t file at all. If the IRS determines you intentionally disregarded the filing requirement, the minimum penalty jumps to $630 per form with no cap. For a business with even a handful of contractors, these add up quickly.
Failing to provide the contractor with their copy by January 31 carries separate penalties on a similar scale.
State Requirements Vary
Many states require you to file copies of 1099-NEC forms with the state tax authority in addition to the IRS. Some states also require contractors to be reported to a new-hire or independent contractor reporting database, similar to how employees are reported. Filing deadlines, thresholds, and procedures differ by state, so check your state’s tax agency website for specific requirements.
Using Software to Manage the Process
If you only have one or two contractors, tracking payments in a spreadsheet and filing 1099s through the IRS IRIS portal works fine. As you add more contractors, dedicated accounting or contractor management software becomes worthwhile. Most popular accounting platforms can track contractor payments throughout the year and generate 1099-NEC forms at tax time, handling both the contractor copies and electronic filing with the IRS.
Some payroll services also offer a contractor payment module that handles direct deposits to contractors on a set schedule, though this is a convenience feature rather than a legal requirement. The cost typically runs a few dollars per contractor per month, which may be worth it if you’re managing a dozen or more contractors and want to centralize records.