Hiring contractors can be a great move for small business owners who want to access top-tier talent without the long-term commitment of full-time employees. However, it’s important to understand how hiring contractors directly impacts your financial management. From how you handle payments to staying compliant with tax regulations, bringing on contractors requires a more nuanced approach than traditional employees. In this blog post, we’ll break down the financial implications of hiring contractors and provide actionable steps to keep your business on track.

The Financial Impact of Hiring Contractors

When you hire contractors, you’re entering into a relationship that offers flexibility but also requires you to manage financial aspects differently. Contractors aren’t on your payroll in the same way employees are, meaning you don’t have to worry about withholding taxes, paying for benefits, or contributing to retirement plans. However, this also means that you need to keep a sharp eye on how you pay them and track expenses to ensure you’re staying compliant with IRS guidelines.

Here’s what changes when you hire contractors:

1. Payment Methods and Fees: Contractors are typically paid via direct transfer, such as Stripe, MelioPayments, or a Venmo Business account. Each of these methods comes with its own fees and tax reporting implications. For example, PayPal charges a fee for business transactions, and using platforms like Venmo or Cash App for business payments could lead to complications during tax season if they aren’t properly tracked.
2. Tax Compliance: Unlike employees, contractors are responsible for their own taxes, which means you won’t withhold taxes from their payments. However, you are still responsible for issuing a Form 1099-NEC for contractors to report their earnings, provided you paid them more than $600 in a year. Missteps in this area can lead to penalties and scrutiny from the IRS.
3. Cash Flow Management: With contractors, your payments will typically vary based on projects or hours worked. This can make cash flow management a little tricky if you don’t account for these irregular expenses in your financial planning. It’s essential to keep your bookkeeping organized so that contractor payments don’t sneak up on you and cause cash flow problems.

Choosing the Right Payment Method

How you pay your contractors can impact both your bookkeeping and financial planning. Let’s break down some of the most common payment methods and their financial implications:

1. Contractor Management Platforms: Tools like Gusto and QuickBooks allow you to handle contractor payments while tracking taxes and expenses in one place. They also generate necessary tax forms, making year-end reporting smoother for both you and your contractors. Using Gusto or QuickBooks for Contractor payments allows you to pay via direct deposit to your contractors.This option is the only one I recommend to my clients.
2. PayPal: While convenient, PayPal charges fees for business transactions, which can add up over time. Additionally, contractors using PayPal will need to ensure they account for fees on their end, so be clear about whether the fee is deducted from their payment or absorbed by your business.
3. Venmo or Cash App: Although popular for personal payments, these platforms can be problematic for business transactions. Payments sent through these apps may not be fully traceable, and there could be confusion when it comes to tax reporting. If you use Venmo or Cash App, it’s crucial to have a paper trail for every transaction to ensure accuracy during tax time.

Actionable Step: Choose a payment method that works best for your business, taking into account convenience, costs, and how easily you can track transactions. Using an integrated system like QuickBooks or Gusto can help streamline payments and keep your records organized.

Managing Contractor Expenses and Deductions

Hiring contractors can lead to significant tax deductions for your business, but it’s important to know how to track these expenses properly. Contractor payments should be categorized separately from other expenses in your books, making it easier to issue 1099s and deduct these payments as business expenses during tax season.

Consider these key points when managing contractor expenses:

• Keep Contracts on File: Always have a contract that outlines the scope of work and payment terms for each contractor. Not only does this protect your business legally, but it also makes it easier to track payments.
• Separate Personal and Business Accounts: Ensure all contractor payments come from a designated business account. Mixing personal and business expenses can cause confusion during bookkeeping and make it harder to justify deductions during an audit.
• Categorize Expenses Properly: Whether you’re paying for marketing services, website design, or bookkeeping, make sure to properly categorize contractor payments in your bookkeeping software. This will make filing taxes much easier and ensure that you maximize your deductions.

Tax Considerations for Contractor Payments

Since contractors are not employees, it’s your responsibility to report what you’ve paid them if it exceeds $600 in a calendar year. This means issuing a 1099-NEC for tax reporting purposes. Failure to issue the correct forms or improperly categorizing payments can lead to penalties from the IRS.

Here’s how to stay compliant:

1. Track All Contractor Payments: Keep accurate records of how much you’ve paid each contractor throughout the year. Use bookkeeping software that allows you to easily generate a report for tax purposes.
2. File Form 1099-NEC: If you’ve paid a contractor more than $600 during the year, you’ll need to issue them a Form 1099-NEC. Most bookkeeping platforms will allow you to do this automatically, or you can work with a bookkeeper to ensure it’s done correctly.

Actionable Step: Before tax season, ensure you have all the information needed for each contractor—social security numbers, addresses, and total payments—so you can issue their 1099s on time.

Conclusion & Call to Action

Hiring contractors can help small business owners access the talent they need without the long-term commitment of a full-time hire. However, it’s essential to understand how contractor payments impact your financial management—from tracking payments to tax compliance. Making sure you have the right systems in place will help you avoid surprises during tax season and keep your cash flow healthy.

If you’re considering hiring contractors, don’t go it alone. Download our free guide, “Hiring A Contractor,” to learn everything you need to know about bringing contractors on board, including key compliance tips and financial management strategies.

Ready to streamline your bookkeeping? Inquire about our professional bookkeeping services today. We’ll help you track contractor payments, file 1099s, and ensure your business is set up for success. Contact us here to learn more!