Hiring contractors can offer numerous benefits to small business owners, including flexibility, access to specialized skills, and cost savings. However, there are also common mistakes many businesses make when bringing contractors on board, which can lead to financial and legal issues. From misclassifying workers to improperly handling payments, these errors can hurt your bottom line and disrupt your business. In this post, we’ll explore some of the most frequent mistakes small business owners make when hiring contractors—and how you can avoid them.

Misclassifying Contractors vs. Employees

One of the biggest mistakes small business owners make is misclassifying workers as contractors when they should be classified as employees. Misclassification can lead to fines, penalties, and back taxes, as both the IRS and state labor departments have strict rules about how workers should be categorized.

For example, Tennessee uses the 20-Factor Test, which provides guidance for classifying workers based on various criteria. These factors include:

• Whether the worker is free from control over how they perform their tasks.
• Whether the worker is required to follow instructions about when, where, and how to work.
• Whether the worker’s services are integrated into the business operations or performed independently.

For instance, if a worker has set hours, submits regular reports, or uses equipment provided by your business, they may be classified as an employee under Tennessee guidelines. On the other hand, if the worker operates their own business, works on their own schedule, and provides their own tools, they are more likely to be a contractor.

It’s important to note that each state’s classification rules may be stricter in certain cases. Misclassifying workers can lead to significant penalties, especially with workers’ compensation and unemployment insurance requirements. Be sure to carefully evaluate each worker using the state’s 20-factor criteria and consult a legal or tax professional if you’re unsure​. For more information, please visit the Department of Labor website for the most up to date information on FLSA here. Be sure to check out all the links.

Navigating Payment Methods and 1099 Obligations

Another common mistake small business owners make when hiring contractors is improper payment handling. Whether it’s using personal accounts to pay contractors or failing to issue the correct tax forms, these oversights can lead to accounting headaches and penalties during tax season.

Choosing the Right Payment Method: Many small business owners use quick and easy payment methods like Venmo or PayPal to pay contractors, which can lead to problems down the road. While these platforms are convenient, they aren’t designed for business payments and don’t always provide the clear records needed for tax purposes.

To avoid issues, consider these payment options:

• Direct Deposit: Pay contractors directly from your business account for accurate tracking. 
• Business Payment Platforms: Use services like QuickBooks, Gusto, or other payroll tools that help manage contractor payments and automate tax form generation.

Issuing 1099 Forms: If you pay a contractor more than $600 in a year, you’re required to issue them a Form 1099-NEC by January 31 of the following year. Many business owners fail to keep proper records of these payments or miss the deadline, which can lead to penalties. To stay compliant, ensure you’re tracking all contractor payments and issuing 1099s as needed.

Actionable Step: Set up a clear payment system for contractors, ideally through a business-focused platform that automates tracking and tax form generation. Keep accurate records throughout the year to avoid tax issues.

How Professional Bookkeeping Can Help You Avoid These Mistakes

Managing contractor relationships can be complicated, especially when it comes to staying compliant with IRS guidelines, tracking payments, and ensuring tax forms are filed correctly. For many small business owners, outsourcing bookkeeping services can help eliminate these common errors and ensure that the financial side of contractor relationships is handled seamlessly.

How a Bookkeeper Can Help:

1. Accurate Classification: A professional bookkeeper can help you navigate federal and state guidelines for worker classification, ensuring you avoid costly misclassification errors.
2. Streamlined Payments: A bookkeeper can set up the right payment systems, ensuring that contractor payments are tracked and managed properly, reducing the risk of missing 1099 deadlines.
3. Expense Tracking: Contractors’ payments need to be categorized correctly for tax purposes. A bookkeeper will ensure that you maximize your deductions and stay compliant with IRS regulations.

The Consequences of Ignoring These Issues: Failing to address these common contractor-related mistakes can lead to financial strain, including IRS audits, penalties, and back payments. Moreover, if you’re using improper payment methods, it can make it harder to track business expenses, which could mean you’re missing out on valuable tax deductions.

Conclusion & Call to Action

Hiring contractors can give your business the flexibility and expertise it needs to grow, but it’s critical to avoid the common mistakes of misclassification, improper payments, and failing to issue 1099 forms. Following both federal and your state’s guidelines ensures your business remains compliant and protects you from unnecessary legal and financial issues.

Want to learn more about hiring contractors without the hassle? Download our free lead magnet, “Hiring A Contractor,” to get a comprehensive guide on the entire process—from classification to payments and compliance tips.

And if you need help managing contractor payments and avoiding tax pitfalls, inquire about our professional bookkeeping services. We’ll help you stay on top of contractor payments, expense tracking, and 1099 filing, so you can focus on what you do best—growing your business. Contact us today to get started!