How to Pay Freelancers: Payment Methods, Tax Forms, and Best Practices

As a small business owner, you're a master juggler: You have to balance various roles and continually optimize your operations, all while keeping an eye on the bottom line. As the employment landscape shifts beneath our feet, the rise of freelancing has become an ever-growing trend. Today, more than ever, self-employed people and small businesses are turning to freelancers to meet their changing needs. 

Paying freelancers can be more complex than issuing regular paychecks to standard W-2 employees. You’ll have to take into account preferred payment methods, schedules, and contractual obligations. Throw tax compliance and a growing range of payment platforms into the mix, and it's easy to see why you might feel overwhelmed. 

What’s the Difference Between an Employee and a Freelancer?

Before we delve into how to pay freelancers, let’s first distinguish between hiring an employee and onboarding a freelancer. Think of freelancers like a great singer at a music venue. They come in, belt out an incredible set, and just like that, they're off to their next gig. 

Unlike traditional W-2 employees, freelancers are independent entities, not an in-house team. So when payment time arrives, it’s important to be prompt. Treating freelancers respectfully nurtures lasting relationships and can enhance your reputation as a great client. 

A Step-by-Step Guide on How To Pay Freelancers

Step 1: Clearly Define the Scope of Work and Payment Terms

Paying your 1099 contractor starts long before the first invoice arrives. Successful freelance engagements hinge on clear, detailed contracts or agreements. Clearly defining project scope, deliverables, deadlines, and payment structures ensures alignment from the get-go. Open communication and mutual agreement on payment terms help to enhance trust and mitigate future misunderstandings.

Step 2: Decide on the Payment Method and Frequency

To facilitate smooth and timely payments, you’ll want to choose a convenient payment method for both you and your freelancer. In addition to figuring out how to pay your freelancer, you’ll also want to decide how often you’re paying them. Common options include:

• Hourly Rates: Paying based on hours worked offers flexibility and real-time tracking. However, be aware of potential time-tracking challenges and communicate expectations.

• Project-Based Payments: For well-defined projects, fixed-rate payments can be a simple, straightforward option. Agree on milestones and deliverables, providing freelancers with a clear path to success.

• Retainer Arrangements: For continuous support, retainers are ideal. A retainer is an agreement where you pay a fixed fee, typically monthly, for an ongoing service.

• Commission-Based Payments: For sales-driven tasks, consider offering commissions to incentivize freelancers. Some agreements are commission-only, while others offer commissions in addition to a standard payment rate. 

Whatever you decide, document it clearly in your contract. 

Step 3: Monitor and Record Completed Work

Transparency is crucial for successful freelance partnerships. Accurately tracking and documenting a freelancer's work progress ensures that payments align with the work delivered. Project management tools or time-tracking software can help monitor completed tasks.

Step 4: Pay on Time According to Payment Terms

Making timely payments is a key ingredient in nurturing a positive relationship with your freelancers. When it comes to paying freelancers, you have to consider your own cash flow management. For instance, you may opt to pay your contractor after 30-60 days from the completion of the work. On the other hand, some businesses choose to process the payment to the contractor as soon as the invoice is sent, effectively providing an "advance" to the freelancer. While this approach can make freelancers happier by ensuring timely payments, it requires careful cash flow management on the business's part. Whatever you decide, make sure it’s outlined and documented in your contract. 

It’s important to stick to the payment deadlines you both agreed on. You're not just keeping your freelancers happy and motivated, but you're also building your reputation as a trustworthy partner in the freelance world. It's like saying "I respect your work and value our relationship" in the most impactful way. That message goes a long way in creating a warm, productive working environment.

Step 5: Keep Proper Documentation

Unlike traditional employees who receive W-2 forms, freelancers are classified as independent contractors. Just because you won’t be issuing a W-2 form doesn’t mean you escape tax paperwork. If you’re hiring freelancers, here are two forms to familiarize yourself with:

• W-9 form: Before making any payments to a freelancer, ask them to complete a W-9 form. This form collects the freelancer's Taxpayer Identification Number (TIN) and certifies that they are not subject to backup withholding. Although collecting a W-9 before making and tracking contractor payments isn’t technically required, it’s a good practice to help avoid the end-of-year rush.

• 1099-NEC form: If you’ve paid a freelancer $600 or more in a year (even across multiple payments), you’ll have to issue a 1099-NEC form. This helps the IRS track how much the freelancer should be paying in taxes. It's your responsibility to fill this out and provide copies to both the freelancer and the IRS by January of the next year.

Common Payment Options for Freelancers:

Freelancer compensation involves numerous payment methods, each with its own benefits and considerations. As an employer, choosing the right payment method can significantly influence a freelancer's experience and satisfaction with your working relationship. Here are some common payment methods for freelancers:

Checks 

Paper checks are traditional and familiar. While they provide a tangible payment record and might be preferred by some, they might not be the most efficient option. Paper checks can get lost in the mail, leading to delays in payment and possible frustrations for both parties involved. Moreover, checks can be susceptible to fraudulent activities, posing a security risk for businesses and freelancers. There's also the risk of bounced checks if there's a cash flow mismatch between when the check is issued and when it is deposited. 

Cash

Cash payments are straightforward but require diligent record-keeping and receipt collection for accounting. However, they might not always be viable, especially for remote or distant projects, or when dealing with large sums of money.

Peer-to-Peer Payment Apps

Peer-to-peer (P2P) payment apps have become increasingly popular for paying freelancers, particularly for smaller, quick transactions. These apps allow users to transfer funds directly from their bank account to the freelancer's account with ease and speed. While peer-to-peer payment apps are convenient and widely accessible, they have their drawbacks, too. A big thing to consider is transaction limits. For example, Venmo Business Profiles that haven’t completed identity verification have a weekly payment limit of $2,499.99 and a weekly bank transfer limit of $999.99. If you pay multiple freelancers and are expanding your business quickly, these transaction limits might mean you need to stagger or delay payments, which is inconvenient for both yourself and your freelancers. Many peer-to-peer payment platforms also charge fees for business-specific transactions or instant transfers. You’ll also want to ensure that your personal and business finances are not mixed. Otherwise, you’ll be untangling a mess of transactions come tax time.

Credit Card

Paying freelancers via credit card offers a level of convenience and can be useful for larger or recurring payments. However, it's essential to consider any associated processing fees or interest charges you or the freelancer may incur. Your freelancer may also encounter a delay between the transaction and when they can access the money, as they often need to transfer the money from the payment processor to their bank through ACH (Automated Clearing House).

ACH Transfer

More commonly known as direct deposit, ACH (Automated Clearing House) transfers are a secure and cost-effective payment method, particularly for domestic payments. Employers can electronically transfer funds directly into the freelancer's bank account, minimizing processing times and reducing the risk of lost checks.

Electronic Fund Transfer (EFT)

Similar to ACH transfers, Electronic Fund Transfers (EFT) enable employers to send payments directly to a freelancer's bank account. EFT is commonly used for international transactions, although it's worthwhile to consider any applicable foreign exchange fees and conversion rates.

Online Payment Platforms

Various online payment platforms such as Upwork or Fiverr securely facilitate transactions between employers and freelancers. These platforms act as intermediaries, offering protection to both parties and streamlining the payment process. Online payment platforms are particularly advantageous for businesses that conduct numerous transactions with freelancers or prefer a centralized payment solution.

How to Choose the Best Payment Method for Freelancers

Deciding how to pay your freelancers is an important decision that needs thoughtful planning. As a small business owner, this choice can have a big effect on your operations and how happy your freelancers are.

8 Questions to Ask Yourself When Deciding How to Pay Freelancers:

• What is the freelancer's preferred payment method? Communicate with the freelancer to understand their preferred payment option and accommodate their needs whenever possible. Your freelancer’s preferred payment method could also change as their business evolves, so finding a platform that provides flexibility is key. 

• What is the frequency of payments? For ongoing or recurring projects where a freelancer will be invoicing you regularly, explore payment methods that offer automation and efficiency, like direct deposit, to streamline regular transactions.

• How time-sensitive is the payment? Some payment methods, like peer-to-peer apps or electronic transfers, offer faster processing times, which can be crucial for time-sensitive projects. Alternatively, paying via ACH (also known as direct deposit) could take between 1-4 business days, depending on the platform you use. 

• What is the transaction amount? For large transactions, consider payment methods that offer security and protection against potential fraud or disputes.

• Are there any fees associated with the payment method? Factor in transaction fees, currency conversion charges, and any other costs related to the chosen payment option.

• How important is record-keeping and financial tracking? Some payment methods offer better documentation and transaction history, which can be beneficial for accounting and tax purposes.

• What level of convenience and ease do you need? Evaluate the user-friendliness of the payment method, especially if you'll be making frequent payments to multiple freelancers.

• Does this payment method comply with laws and regulations? Don’t get yourself in hot water—ensure that the chosen payment method complies with financial regulations and tax laws.

By asking yourself these questions and looking at the needs of your freelancing arrangements, you can make an informed decision on the best payment method. Remember, the goal is to help ensure a great working experience for both you and your freelancers.

Simplify Your 1099 Contractor Management with Found

Working with contractors is a fantastic way to get expert help and boost productivity in your business. Finding, hiring, and managing great contractors and freelancers can take time and know-how, but is well worth the investment.

When it comes to managing the financial aspects of dealing with contractors, a tool like Found can be a huge help. With a range of tools to help with 1099 contractor management, onboarding and paying contractors has never been easier. No more losing sleep over tax forms and tracking payments. We’ll collect W-9s and auto-generate 1099-NEC forms for your contractors. All you have to do is file. In addition, Found’s automated accounting and tax tools help you spend less time on paperwork and get back to what matters—building your business. Try Found for free today!

Frequently Asked Questions about Paying Freelancers

What payment methods are commonly used for paying freelancers?

Freelancers often accept payments through numerous payment methods, such as credit cards, peer-to-peer payments, or ACH transfers. Each method has its own benefits and considerations. The choice of method may depend on the freelancer's location and personal preference. 

How often should I pay freelancers?

The payment frequency can vary, but many freelancers prefer to be paid consistently. Common options include paying weekly, bi-weekly, or monthly. Clarify the payment schedule in writing with your freelancer to avoid any misunderstandings.

Should I use contracts or agreements when hiring freelancers?

Absolutely. A clear contract or agreement helps protect both parties' interests. It outlines payment terms, project scope, deadlines, and other essential details. It's a good practice to have legal documentation for each freelance engagement.

How do I handle taxes when paying freelancers?

Freelancers are usually responsible for their own taxes. However, as someone hiring 1099 contractors, you have certain tax obligations, too. For example, if you pay a freelancer more than a certain amount, you’ll need to issue them a 1099-NEC form.

Can I negotiate payment rates with freelancers?

Yes, you can often negotiate payment rates with freelancers. It's crucial to have an open discussion about rates upfront to ensure both parties are satisfied with the compensation for the work.

What's the best way to track hours worked by freelancers?

Various time-tracking tools, such as Toggl, Harvest, and Clockify, can help you and the freelancer accurately monitor the hours worked on a project. Ask your freelancer if they have a preferred time-tracking method or tool.

Can I pay freelancers in advance?

Yes, you can pay freelancers in advance, especially for longer projects. It's a sign of trust and can help secure their commitment to the project. However, ensure the contract outlines the terms to avoid misunderstandings.

The information on this website is not intended to provide, and should not be relied on, for tax advice. Found's core features are free. They also offer a paid product, Found Plus.