Knowing how to pay 1099 employees makes good business sense for companies that work with independent contractors or freelancers. Even if you don’t currently rely on contract help, chances are you’ve crossed paths with someone who offers it. A 2025 report from MBO Partners found that 5.6 million independent workers earned more than $100,000 annually (up from 4.7 million in 2024), and 36% of traditional workers reported having a side gig. With numbers like these, understanding how contractors get paid — before you need them — can save time, confusion, and compliance headaches later.
What you’ll learn
What you’ll learn
Key takeaways
- Though businesses don’t withhold taxes from independent contractor pay, they must report payments of $600 or more in 2025, and $2,000 or more in 2026, using Form 1099-NEC
- W-2s and 1099s serve different purposes: employees receive a W-2, while independent contractors and freelancers receive a 1099
- Common contractor mistakes include misclassifying workers, mixing employee and contractor payroll processes, and paying contractors without a formal agreement
- Payroll software for small businesses can help manage compliance and tax requirements when paying employees, independent contractors, or both
To better understand how to pay employees with a 1099, this guide explains how independent contractor taxes work, different payment structure options, and other necessary forms and protocols — all which can be made easier with automated payroll software.
What makes 1099 payments different from payroll?
In a nutshell, the difference between employees and contractors hinges on control. In other words, employers usually have a say in an employee’s work hours and methods, while independent contractors (or 1099 workers) have more freedom in how and when they work. Likewise, employees typically receive benefits (such as health insurance) and have taxes withheld from their paychecks by employers, while contractors don’t receive employee perks and are responsible for their own taxes.
To learn more, we spoke with Marit Burmood, a CPA, small business coach, and frequent contributor, about the key differences between paying a W-2 employee and a 1099 independent contractor.
Key differences between paying a W-2 employee versus a 1099 independent contractor?
‘While the foundational differences between W-2 employees and independent contractors lie in factors such as control and economic dependence, evaluating how to classify a worker is much trickier than it seems,” Marit explains. “Small business owners not only need to apply the IRS criteria, but they also need to take into account the Department of Labor AND the applicable state Department of Labor tests as well.”
Test time
- The IRS applies a “Common Law Test” which examines three main factors such as behavioral control (who decides when, where, and how the work gets done), financial control (who bears the economic risk and who makes the business investment decisions), and the type of relationship (how permanent is the arrangement and is the work integral to the core business).
- Meanwhile, the Department of Labor uses the “Economic Reality Test,” which includes looking at six factors to determine how to classify the worker, and many states have adopted their own standards that an employer must use in addition to the other tests.
— Marit Burmood, CPA, Enrolled Agent, Small Business Coach
For anyone with plans to hire, these are distinctions you’ll want to be familiar with. The Internal Revenue Service (IRS) strongly cautions against misclassifying employees, whether they are an independent contractor or a full-time employee. If your business misclassifies an employee, for example, you can be held liable for employment taxes for that worker, which requires you to withhold and pay income taxes, Social Security and Medicare taxes, and unemployment taxes.
Contractors are in a different boat when it comes paying taxes. Even though your business is not responsible for withholding taxes from their paychecks, you are required to:
- Report $600 or more in payments to independent contractors in 2025
- $2,000 or more in 2026 to the IRS via Form 1099-NEC, Nonemployee Compensation.
Did you know?
The 1099 threshold for 2026 increased due to legislation passed under the One Big Beautiful Bill Act.
The key takeaway is that payroll for employees and independent contractors must be kept separate. This will prevent errors, ensure that payments and tax withholdings are correct, and guarantee compliance.
If this feels like a lot to keep straight, the table below highlights the core differences between paying employees and independent contractors at a glance.
| What to look for | W-2 employees | 1099 contractors |
| Who controls the work | Employer controls schedule and methods | Contractor controls how and when work is done |
| Tax withholding | Employer withholds income, Social Security, and Medicare taxes | No tax withholding by the business |
| Benefits eligibility | May receive benefits like health insurance | Not eligible for employee benefits |
| Year-end tax form | Form W-2 | Form 1099-NEC |
| Employer tax responsibility | Employer pays payroll taxes | Contractor pays self-employment taxes |
Now that we better understand the basics, let’s find out more about how to make sure wages get from point a to point be without any problems along the way.
The process: how to pay 1099 workers properly?
Accurately paying remote and contract employees requires a focus on compliance and thorough recordkeeping from the start. All the information you gather during the hiring process will come in handy when it’s time for end-of-year reporting.
Here are the three main steps when it comes to paying 1099 workers properly:
1. What information should I collect from a new 1099 contractor before making payments?
- Before any work begins, you should have completed W-9 forms from contractors (if someone you want to work with doesn’t have one or won’t produce it, that should make you take pause and consider looking elsewhere for help).
- Also, verify contractor Taxpayer Identification Numbers (TINs)
- Store this information digitally
Make sure everything is in order before work begins or payments are made.
2. Set clear payment terms and rates
The next step in the process is to determine whether you will pay freelancers hourly or on a project basis. You should also agree on rates and terms, such as payment dates and schedules, up front. This should all be spelled out in a clear, signed contract. Don’t forget to take the time to document and save this information in an easy-to-access place.
3. Choose a payment method
When paying independent contractors, you’ll have options to choose from, including:
- ACH or direct deposit: This method is affordable and relatively easy to set up, but it does require gathering and storing contractor bank details.
- Wire transfers: While this can be fast and efficient, wire transfers are also the most expensive payment option for your business.
- Checks: A paper check is simple to produce but slow and less desired by most workers.
- Online platforms: Using an online platform offers a speedy option that is also be ideal for international payments.
Ultimately, the best method is the one that is preferred by your payroll team. For many businesses, it makes sense to use the same payment method for both employees and independent contractors, while keeping the two payroll processes distinct.
Now that we’ve covered the common ways contractors get paid, you may wonder whether paying by the hour, a flat project fee, or if an ongoing retainer makes the most sense. Once again, we caught up with Marit for her take.
Can I pay 1099 contractors a fixed project fee or only hourly rates?
“Yes, you can pay contractors a fixed project fee. In fact, in many cases, this compensation structure supports the independent contractor classification. This is because paying by the project instead of by the hour suggests that you care more about the deliverable than controlling the hours spent to get there. In theory, you are paying someone for their expertise and results, rather than for their time.”
While hourly rates aren’t completely off the table, be aware that if this payment arrangement is combined with other controlling factors such as when, where and how they work you are building the case that the worker should be classified as an employee.”
— Marit Burmood, CPA and OnPay subject matter expert
For compliance protection, make sure to keep records of every payment you make, with invoices, contracts, and receipts.
Tax time: preparing for 1099-NEC reporting
When you set up a payment process for independent contractors, it’s also a good idea to establish a process for 1099 reporting to support tax compliance. At the end of the year, you will issue 1099-NEC forms to contractors who you have paid $600 or more to in 2025, or $2,000 or more in 2026.
On the 1099-NEC form, you should include the contractor’s name, amount paid, and TIN. You must issue this form by January 31 of the following year, and you must e-file if you have 10 or more returns. Note that in 2026 and 2027, you do get a little grace period since January 31 falls on a weekend – so you get until the next business day Monday, February 2. That said, sending this information at the last minute is usually not a best practice.
What is the difference between a 1099-NEC and other 1099 forms (e.g., 1099-MISC)?
Keep in mind the distinction between a 1099-NEC and 1099-MISC. The 1099-NEC reports payments for services from nonemployees, such as contractors, while the 1099-MISC covers other payments, such as rent, royalties, and legal settlements.
How do I pay taxes as a 1099 employee? Be prepared for this question from newer independent contractors who may not be familiar with the rules for freelancers. You can refer them to an accountant or someone within your business who supports independent contractors.
All contractors will need to file a Schedule C (Form 1040) for income, a Schedule SE form for self-employment tax (which covers Social Security and Medicare taxes), and a Form 1040-ES for their quarterly estimated payments.
Now that we have a better understanding of the rules regarding reporting, let’s take a look at some of the mishaps businesses should avoid when making payments.
What common mistakes do businesses make when paying independent contractors?
Here’s what you’ll want to steer clear of when working with contractors and those in the gig work space:
- Misclassifying workers: Make sure every worker in your organization is correctly classified as an employee or an independent contractor and that their forms match up accordingly. And if you’re unsure how they should be classified, try our worker classification checker. And know that you can always speak with an employment attorney about your situation if you’re unsure about your obligations.
- Paying without contracts or W-9s: While paying freelancers under the table might sound enticing, it can backfire. Having a contract keeps things on the up and up, detailing payment rates and structure, agreed-upon terms of work, and whatever else you’ve agreed to. This can be invaluable in the event of a dispute.
- Mixing 1099 and W-2 payroll processes: Combining all of your payroll into one unified process may seem most efficient, but mixing 1099 and W-2 payroll can create nightmares for your payroll team and workers alike. Keep these processes separate to make sure that you accurately withhold taxes as needed and pay all of your workers on time, every time.
In addition, we asked Marit if there’s any under-the-radar mishaps employers end up making.
- The double reporting trap: Knowing when to file 1099’s can be confusing, especially if payments to the contractor were made via credit card or third party platforms like PayPal, Stripe or Zelle. This is because not all payment methods trigger reporting. If you are unsure about whether you need to file a 1099 for your contractor, try this searchable database of 70+ payment providers and their specific filing obligations.
- Issuing 1099s to corporations: Generally, you don’t need to issue 1099-NECs to corporations (which includes businesses taxed as S-Corporations), with two major exceptions. You must always issue a 1099 to attorneys for legal services, even if they are incorporated, and generally you must issue 1099-MISC for medical and health care payments to corporations. This is why it is so important to collect W-9’s up front since these tell you what the contractor’s entity type is.
- Long-term, exclusive relationships: If your “contractor” has been with you for years, works the same hours each week, and has no other clients, this relationship will look a lot like an employer-employee arrangement. Under both the IRS common law test and the DOL’s Economic Reality Test, these types of indefinite and exclusive relationships suggest employment.
The good news is that you can avoid these potential pitfalls with a little know-how. Using automated payroll and 1099 software can also simplify the payroll process for all employee types.
Hassle-free payroll – whoever you hire
“OnPay is both easy to use and has powerful features. Everything you need to run payroll for both W-2 and 1099 employees. Integrates well with QuickBooks and the price is good too! I haven’t found a payroll need I have that I can’t do through OnPay.”
— David Sierra, Cutting Edge Fencing
Make compliance easier with payroll tools
When you work with independent contractors, automated payroll software can help take the stress (and mistakes) out of payroll processing. OnPay helps small businesses pay independent contractors and employees securely by simplifying workflows with auto-recording, year-end filings, W-9 collection, and other crucial processes.
If you’re looking for a more efficient way to manage employee and contractor payroll and avoid common errors in tax withholdings, get started with OnPay today. We can help you streamline your payroll process and make sure you’re staying compliant. Our award-winning payroll software will give you more time to focus on what you do best.
Take a tour to see how easy payroll can be.
Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.