Discover the best payment methods for contractors. Should you pay them via cash or check? And what do you do if you don’t have a W-9?
Paying independent contractors doesn’t have to be a headache. There are many tools out there that make this job easier for small business owners like you and me. Let’s look at the most popular ways to pay contractors and see if those are actually the best ways.
Many people hear that paying by cash is a good thing to help you stay on budget and not overspend. Usually, I would agree. For business owners, however, there are pitfalls to paying by cash. The hassle and tax implications may have you re-consider paying anyone by cash or check! This is especially true of independent contractors since you are required to report their income earned to the IRS.
Payment Methods: Cash, Check, or ACH
First, I have to tell you straight up that paying with cash isn’t the best way to pay your independent contractors. Lots of people try to pay with cash as a way to avoid having to pay extra taxes. Don’t play that game. You’ll need to keep a record of how much you pay people that work for you. If you haven’t done it before, it’s tough to keep good records of cash payments.
Checks aren’t much better. While you can still keep track of the check numbers in your accounting software, you are still required to send out 1099 forms when you pay with this method. Checks may be easier than cash but there are tax implications you must keep up with.
One of my clients still has a few customers who pay him by check. He’s trying to move these customers to credit card only, but it’s been a slow transition. Unfortunately, he once lost an entire stack of checks! He had to go back to these clients to ask them to confirm the checks had not be cashed, then ask them to re-send him a new check. Not the best customer experience!
The same applies to bank transfers and ACHs. While you can trace these through your bank statements, you must still send out a 1099. Many business owners do not know this or forget to do it.
W-9 Forms For Independent Contractors
No matter which payment method you use, it’s required by the federal government for you to have a W-9 on file before you receive any services from them.
To support and grow your business, did you pay any independent contractors by cash, check, wire transfer, electronic check, ACH, online bill pay (bank to bank), or direct deposit last year? If so, did you request a completed W-9 form prior to receiving services?
If you weren’t aware of this IRS requirement (mentioned in Chapter 16 in Small Business Finance for the Busy Entrepreneur), you should be collecting W-9 forms from all independent contractors who you pay in total over $600 in a calendar year. It is your responsibility to mail them a 1099-Misc form by January 31st of the following year. If not, you could be fined $50 – $520 per missing form!
What To Do If Someone Refuses to Send a W-9 Form
If an independent contractor refuses to send you a W-9 form, you have 3 options you can choose from.
- Hire someone else – If you are proactive and send the form ahead of the payment and services being delivered, then you can choose to not work with the person. Hire another contractor who will agree to complete the W-9 form.
- Mark “REFUSED” – If you have already paid the independent contractor, then you can issue the 1099 form and put the words “REFUSED” in place of the social security number.
- Withhold 28% for IRS – If you decide to work with the independent contractor in the future, you are required to withhold back-up withholding of 28% of any amount that you pay the independent contractor. Then, you need to send that withholding to the IRS.
To be on the safe side, my CPA recommends I collect W-9 forms from all independent contractors prior to paying for their service. Remembering the $600 threshold, this is really good advice even if you’re only paying them $400 in February. You may later decide to hire them in September for $300 of services. In this case, you would need a completed W-9 form on file (since $400 + $300 = $700; now over the $600 threshold) and would have to issue a 1099-Misc form the following year.
It is much easier if you do all the necessary paperwork upfront in the business relationship because it can be awkward and contentious if the person refuses after the fact.
Payment Methods Case Story
Previously, since I knew about the $600 threshold I didn’t collect a W-9 form from anyone who I paid less than $600. However, at my CPA’s recent advice, I wanted to get W-9 forms from everyone just to be on the safe side. One of my independent contractors refused. She had never completed any tax forms before and has not been reporting her income to the IRS. Yikes! You can bet that I don’t refer business to her or hire her anymore!
My CPA states that it is her responsibility to report all income that she earns, and not my problem if she doesn’t. If she doesn’t make enough income in the business, she would be exempt from self-employment tax. Luckily, my CPA says that I am safe since I paid her a total of less than $600 last year, so I am not required to have a completed W-9 form from her. However, she did suggest an option was to still issue a 1099-Misc with “Refused” in the social security section.
How To Record Paying Both Cash And Credit
One confusing thing that I have learned is if you pay an independent contractor through various methods, including both cash and credit card, then you only have to file a 1099-Misc form if the total cash payments are over $600. And you only need to report the amount of the cash payments. This is because the credit card companies and third-party networks like PayPal are required to report those payments from their side on a 1099-K.
Action Items by January 31st:
What can you do if you just learned about these requirements and have paid $600 or more to independent contractors?
- Confirm if you need to file the Form 1099-Misc.
- If there is limited time to mail and receive a W-9 form, request and complete all the required forms electronically at 1099online.
- In the future, re-consider working only with independent contractors who invoice and allow credit card payments.
Again, make sure you do all of this before January 31st. Otherwise, you could be fined for intentional disregard for up to $530 per return.
The Easiest Way to Make Payments
If you want to find the easiest way to make payments to contractors, look no further. Using invoicing tools like FreshBooks allows you to accept online payments via all major credit cards and Apple Pay. A lot of people want to pay with credit cards because they often have reward perks tied to them, which can make this a win-win situation.
By the way, if you are looking for a credit card with great perks, I personally recommend and use Chase Ink, which has an unlimited 1.5% cashback for all purchases.
Plus, you can learn more about FreshBooks (and why I prefer it over QuickBooks).
Payment Methods: Final Thoughts
Even if you are just paying yourself as the business owner, it’s important to keep your accounting organized and to follow all the tax rules. Maintain clear records so you can report things properly at tax time. Avoid paying by cash if you can. Always make sure you have W-9s on file if you are paying independent contractors. If you have any other questions, please reach out! I’d love to answer any questions you have about small business finances.
Have you ever had a contractor refuse to complete a W-9 form? If so, how did you handle it? If you didn’t know about these requirements until now, do you have a CPA that you are currently working with?