Be Direct: Paying Employees and Independent Contractors

Oct 10, 2017 | Jessica Ogilvie

There are a lot of ways to get money from Person A to Person B these days. You can use PayPal or Venmo, send money between banks, hand over cash or a check, fill out forms at Western Union, deploy a carrier pigeon, and so forth. And those are all great options for reimbursing a friend for pizza and beers, or buying your dog a sweater on Etsy; but when it comes to paying employees, the experts we spoke to believe that the old-fashioned way — paper checks or direct deposit — is still the best option.

The first order of business is to make sure you know the difference between an independent contractor and an employee — and recognize which category your hires fall under.

Who’s Working for You?

Employees and contractors can be separated along pretty clear lines.

Employees: paid hourly wages or salaries covered by federal and state employment and labor laws *have income tax, Social Security, and Medicare — also known as FICA (Federal Insurance Contributions Act) — withheld from their paychecks.

Independent contractors or freelancers: paid in various ways, including flat rates, hourly rates or project-based rates not covered by employment and labor laws do not have FICA taxes withheld.

Those differences mean that paying employees and paying contractors amount to two very different tasks, says Laura D. Adams, host of the Money Girl podcast and author of Money Girl’s Smart Moves to Grow Rich.

“If you are paying contractors, you could probably get away with using systems like PayPal or others,” she says. “But you still have to keep very good records; if you pay anybody more than $600 a year, you have to issue them a tax form at the end of the year.”

Don’t Screw Up the Paperwork

That tax form is known as federal Form 1099 Misc, which is sent to the IRS as part of your business’s annual taxes. A copy of the form is also sent to the contractor. The danger of using a system like PayPal for contractors, then, says David Worrell, a managing member of Fuse Financial Partners and author of The Entrepreneur’s Guide to Financial Statements, is that it’s easy to lose track of your business costs on it, thereby potentially mismanaging 1099s.

“If you start mixing payroll with your eBay purchases on PayPal,” he says, “you’ll be very confused very quickly.”

When it comes to employees, things get even more complicated. You’ll need to track their wages and taxes, calculate FICA, incorporate overtime where necessary, determine withholdings, and more. “Payroll gets pretty complicated,” says Adams. “There’s a lot of calculations that go into it.”

Keep Track of Your People

That’s a large part of the reason that both Worrell and Adams suggest sticking to paychecks or direct deposit for both independent contractors and employees; they’re much easier to track, and have been standardized for years so you won’t be reinventing the wheel. Both Worrell and Adams also recommend using a system like QuickBooks or FreshBooks, which will do a lot of the thorny number-crunching for you. Those systems also help keep contractors and employees in separate categories, if you’ve utilized the services of both.

Plus, says Worrell, your stress level is high enough — you don’t need to add unnecessary payroll difficulties to it.

“Payroll is complicated and closely watched by the government,” he says, “so you’ll sleep a lot better knowing it’s done right.”