Typical payment terms for contractors include net payment terms, payment schedules, penalties for late payments, and best practices for structuring payments. For those keeping score, an independent contractor is a self-employed worker who is contracted to do a job for a third party.
Key takeaways to consider
- Net-30 payment terms are standard for contractors, but offering faster payment options can help you attract and retain top talent.
- Clear payment schedules and automated invoicing help prevent late fees and keep your contractor relationships drama-free.
- Progress payments on bigger projects protect both you and your contractor – they get paid regularly, and you avoid one huge bill at the end.
But what if you are just starting to work with contractors and trying to figure out a payment structure that works best for everyone? In this guide, we’ll cover some of the common payment terms for contractors, typical pay schedules, and some invoicing best practices.
Key components of payment terms for contractors
What are typical payment terms for contractors? Some of the key components are:
- Payment schedules: When will payments be made? What, if any, late penalties exist? Payment schedules may also incorporate progress payments, which are made based on a specific percentage of work being finished.
- Payment timelines: Similar to payment schedules, payment timelines define when funds are received or paid, which is important to a business’s overall budgeting and cash flow picture.
- Work scope: This includes a definition of the tasks, deliverables, any materials, and timelines expected for a given project.
When businesses and independent contractors negotiate payment terms, they’ll want to figure out preferred payment methods and the scope of work before signing on the dotted line. Gig workers and independent contractors are in greater demand than ever, so they have some bargaining power when setting the terms of a contract, and it pays to hammer out reasonable terms for all parties involved.
There are some other considerations to consider. To learn more we spoke with Peggy James, certified public accountant (CPA) and one of OnPay’s subject matter experts, who explains there are specific documents you’ll want to keep in mind.
Paperwork to keep top-of-mind
“A business that pays an independent contractor is required to send a Form 1099-NEC for any payments totaling $600 or more during the calendar year as long as the contractor is not being taxed as a corporation. In order to send the 1099, you’ll need the business or individual’s name, tax ID (either a Social Security or employer identification number), federal tax classification (sole proprietor, corporation, etc.), and mailing address. The best way to collect this information is to have the contractor provide a completed Form W-9.”
— Peggy James, Certified Public Accountant (CPA) and OnPay expert contributor
So how do most business owners go about getting the information? “The best practice I recommend to clients is to collect this information as part of the onboarding process for the contractor,” says Peggy. “It’s much easier to obtain this information at the start of the relationship than it is to try to go back and collect the information after the contractor has been paid.”
Next, let’s cover some common payment terms contractors are likely to be familiar with.
What are typical payment terms for contractors?
For contracts with freelancers, consultants, and independent contractors, various payment terms and schedules are available.
Prepayment terms
A prepayment is a type of payment made to a contractor before the work begins. It is typically a percentage of the total project fee that is made in good faith, and this payment is often used to cover project-related expenses.
Progress payments
On the other hand, progress payments are payments for partial work, often on a longer-term project. Partial payments give independent contractors the opportunity to bill and receive payment for partial work and can mitigate the possibility of huge invoices at the end of a project.
Pro tip
Progress payments can also help to protect the business if the contractor is unable to complete the project on time for some reason.
Net payment terms (Net 10, Net 30, Net 60)
Net payment terms determine how long a customer has to make a payment following the receipt of an invoice. Net payments are the most common type of payment to independent contractors. Here are some typical examples:
- Net 10 means that the payment is due within 10 days of invoice receipt;
- Net 30 indicates that payment should be made within 30 days; and
- Net 60 requests payment within 60 days of invoicing.
Payment on delivery
Finally, payment on delivery is payment when an item or a project is delivered in full, which means your business would pay the full amount when an independent contractor completes a project and submits an invoice.
Late payment penalties
Late payment penalties are a common component in contracts. These penalties can include:
- Fees: A contract may include a specific fee for late payment.
- Interest: An interest penalty ranging from 0.5% to 5% is common in contracts. Often, the interest grows each month that late payments are made.
- Legal compensation: Contractors can take legal action for late payments if the party does not provide a suitable reason for nonpayment or late payment.
To prevent late payment penalties, independent contractors can send out automated payment reminders and remind clients quickly if a payment is ever late, and businesses can turn to automated invoicing procedures.
Negotiating payment terms
Negotiating payment terms is a common practice for independent contractors and clients. When negotiating payment terms with a contractor, consider the following:
- Do your research: It helps to come armed with average payment and salary terms for the work being proposed and to understand the full scope of the project.
- Be reasonable: Make sure payment terms meet the needs of both parties, which may involve some concessions on both ends.
- Set clear expectations: Make sure that payment and other contract terms are established and understood clearly before any work begins.
- Build in incentives: If you are on a tight timeline, consider bonuses for early completion.
- Maintain solid records: Both parties should maintain complete records related to payments and other contract terms.
If you need support in paying remote employees and contractors, OnPay can help you review pay schedule options and discuss payment terms.
Invoicing best practices
Efficient and effective invoicing is critical to your organization’s overall financial health. While invoicing is rarely a favorite task, following top industry standards can make this process easier.
Here are some invoicing best practices:
- Label: This sounds obvious, but labeling each invoice with the word “invoice” will make it easy to identify and easier to move through the system and maintain all of your contractual obligations.
- Have a system: Don’t try to wing invoices. Make sure your business has clear procedures and payment schedules, including billing intervals, in place. Standardization goes a long way in invoicing. Likewise, invoices should be kept separate from other accounting work.
Related reading
For a deeper dive on documentation, read our in-depth guide to the differences between invoices and receipts to make sure you’re getting everything right.
- Determine preferred payment methods: How does your business prefer to pay independent contractors? This should be spelled out in contracts before work begins so there are never any surprises.
- Automate, automate, automate: Automated invoicing processes ensure that nothing is ever overlooked or paid late. Online invoices can be a great option for smaller businesses.
- Keep track: Finally, make sure you have a system that tracks invoices and payments. Connect and communicate with clients if there is ever an issue. Review and reconcile on a regular basis.
It is also a good idea to have dispute resolution policies in place if issues ever crop up.
Understanding common contractor payments terms can help when hiring
Farming out projects to contractors can make a lot of sense for project work and for growing employers without the resources to bring on full-time W-2 employees. OnPay’s contractor payroll software is built for businesses of all sizes and can automate payroll processing so working with freelancers or gig workers won’t cause stress. As you keep your company moving forward, our team is ready to help and here if you have any questions.
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.