The tax rules for paying independent contractors come down to three things: collect a signed Form W-9 before you release any money, keep clean records of what you paid and when, and file Form 1099-NEC by January 31 for any contractor you paid $2,000 or more during the calendar year.1Office of the Law Revision Counsel. 26 USC 6041 – Information at Source2Internal Revenue Service. Reporting Payments to Independent Contractors The One Big Beautiful Bill Act raised that reporting threshold from $600 to $2,000 in 2025, with inflation adjustments going forward. Miss the paperwork and per-form penalties climb to $680.
Get a W-9 Before You Pay
The single most important step happens before any money changes hands. Have the contractor complete IRS Form W-9, which captures their legal name, business address, federal tax classification (sole proprietorship, LLC, C corporation, or S corporation), and taxpayer identification number, either a Social Security Number or an Employer Identification Number.3Internal Revenue Service. About Form W-9, Request for Taxpayer Identification Number and Certification The contractor signs under penalty of perjury that the TIN is correct and states whether they’re subject to backup withholding.
Chasing down a W-9 after payment is where businesses run into trouble. If the contractor never sends one back, or the TIN turns out to be wrong, you’re on the hook for backup withholding you didn’t collect. Get the form first, then pay.
Alongside the W-9, require a proper invoice for each payment: itemized services, dates worked, a unique invoice number, and the total. That paper trail supports the deduction on your return if the IRS ever asks.
The $2,000 Threshold and Form 1099-NEC
Once your payments to a single contractor for services reach $2,000 or more in a calendar year, you must file Form 1099-NEC reporting the total, send a copy to the contractor, and file with the IRS.4Office of the Law Revision Counsel. 26 USC 6041A – Returns Regarding Payments of Remuneration for Services and Direct Sales The threshold applies to payments for services only. Buying physical goods from a vendor doesn’t trigger the form.
Form 1099-NEC covers nonemployee compensation: fees, commissions, prizes for services, and similar payments. Other payments to contractors, such as rent for equipment or royalties, belong on Form 1099-MISC instead.5Internal Revenue Service. Instructions for Forms 1099-MISC and 1099-NEC For a standard services-for-fee arrangement, the 1099-NEC is the only form you need.
The deadline is January 31 of the year after payment, for both the IRS copy and the contractor copy. When January 31 falls on a weekend, the deadline shifts to the next business day.
When You Must File Electronically
If you file 10 or more information returns of any type in a year, you must file electronically. That count combines all your 1099s, W-2s, and other information returns. Six 1099-NECs plus four W-2s puts you over the line and every one of them has to be e-filed.6Internal Revenue Service. General Instructions for Certain Information Returns (2025)
Payments Through PayPal, Venmo, and Similar Platforms
Third-party settlement organizations must issue their own Form 1099-K to a recipient who exceeds $20,000 and 200 transactions on the platform in a calendar year.7Internal Revenue Service. IRS Issues FAQs on Form 1099-K Threshold Under the One Big Beautiful Bill A platform-issued 1099-K does not relieve you of the 1099-NEC obligation for the same payments. The forms serve different purposes and neither cancels the other.
Reimbursements: When They Land on the 1099
Whether an expense reimbursement counts as reportable compensation depends on whether your arrangement is an accountable plan. Three conditions have to be met: the expenses must have a direct business connection, the contractor must substantiate them with receipts within a reasonable time, and any excess amount must be returned. Meet all three and the reimbursement stays off the 1099-NEC.
Fail any one of them and the entire reimbursement becomes compensation, reported in box 1 of the 1099-NEC. A flat “expense allowance” with no documentation requirement is the classic trap: you’ve effectively increased the contractor’s reportable income and complicated your own deduction.
Backup Withholding at 24 Percent
You normally don’t withhold anything from contractor payments. The exception is backup withholding. If the contractor doesn’t give you a valid TIN on a W-9, or the IRS notifies you that the TIN they provided is wrong, you must withhold 24 percent of every payment and send it to the IRS.8Office of the Law Revision Counsel. 26 USC 3406 – Backup Withholding9Internal Revenue Service. Backup Withholding
Skip the withholding when it was required and you become personally liable for the tax. The clean fix is procedural: no signed W-9, no payment.
Penalties for Late or Missing 1099s
Penalties run per form and escalate with delay. For returns due in 2026:10Internal Revenue Service. Information Return Penalties
- Up to 30 days late: $60 per form
- 31 days late through August 1: $130 per form
- After August 1 or never filed: $340 per form
- Intentional disregard: $680 per form
Small businesses (average annual gross receipts of $5 million or less) get lower annual caps, but the caps still run into six figures. A form filed a few days late is a small hit. Repeatedly ignoring the requirement is what draws serious penalties and additional audit attention.
Foreign Contractors Work Differently
If your contractor is not a U.S. person, the W-9 doesn’t apply. Collect Form W-8BEN from a foreign individual or Form W-8BEN-E from a foreign entity. The form establishes foreign status and lets the contractor claim any reduced withholding rate available under a tax treaty.11Internal Revenue Service. Instructions for Form W-8BEN (10/2021)
Without a valid W-8BEN on file, you withhold 30 percent of the payment and remit it to the IRS.12Office of the Law Revision Counsel. 26 USC 1441 – Withholding of Tax on Nonresident Aliens The 30 percent applies to services compensation, royalties, rents, and most other U.S.-source income paid to foreign persons. Treaty benefits require the contractor to make the claim on the W-8BEN and supply a foreign tax identification number. W-8BEN forms expire every three years, so track renewals if the relationship is ongoing.
Don’t Misclassify an Employee as a Contractor
Calling a worker a contractor when they should be an employee is one of the most expensive mistakes in this area. The IRS looks at three categories of evidence: behavioral control (who directs how the work gets done), financial control (who controls pay method, expense reimbursement, and similar business terms), and the type of relationship (written contracts, benefits, whether the work is a key part of your business).13Internal Revenue Service. 14Office of the Law Revision Counsel. 26 USC 3509 – Determination of Employer’s Liability for Certain Employment Taxes Additional penalties for failing to withhold and deposit employment taxes can stack on top.
When the classification is a genuine close call, either you or the worker can file Form SS-8 and ask the IRS for a formal determination.15Internal Revenue Service. About Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding It takes time, but you get a defensible answer instead of a guess.
How Long to Keep the Records
Hold every W-9, invoice, payment confirmation, and filed 1099-NEC for at least three years from the filing date of the return that reported the payments.16Internal Revenue Service. Topic No. 305, Recordkeeping That’s the general statute of limitations for the IRS to assess more tax. If income was understated by more than 25 percent, the window stretches to six years, and there’s no time limit when fraud or a failure to file is involved.17Internal Revenue Service. How Long Should I Keep Records Digital and physical backups of contractor payment records are cheap protection for the deductions those payments support.