Hiring help without hiring employees is how most small businesses grow, and the tax system attaches two distinct obligations to it: classifying the worker correctly, and reporting what you paid them. Both are simpler when your books are set up for them from the first payment.

Contractor or employee? The question that matters most

The distinction isn't a label you choose — it's a legal conclusion drawn from the working relationship. Misclassifying an employee as a contractor exposes you to back employment taxes, penalties, and state enforcement, which has grown notably aggressive.

The IRS looks at the whole relationship through three lenses:

  • Behavioral control. Do you direct how, when, and where the work is done, or only the result? Training someone, setting their hours, and requiring your tools all point toward employee.
  • Financial control. Does the worker have their own business — other clients, their own equipment, opportunity for profit or loss, invoices sent to you? Contractors run businesses; employees are paid for time.
  • Relationship type. Ongoing, indefinite, core-to-your-business work looks like employment. Project-based, defined-scope work looks like contracting. A written contract helps but doesn't override reality.

A web designer building your site while serving five other clients: contractor. A "contractor" who works only for you, forty hours a week, on your schedule, doing the thing your business sells: probably an employee no matter what the agreement says. State rules can be stricter than the IRS test — California's ABC test being the famous example — so check your state if you're near the line, and get professional advice before scaling a contractor-heavy model.

The W-9: collect it before the first payment

Before paying any US contractor, have them complete Form W-9, which gives you their legal name, business type, and taxpayer identification number. You'll need it to file their 1099 — and if you don't have a TIN on file, you're technically required to withhold 24% backup withholding from their payments.

The moment to collect a W-9 is before money moves; contractors respond quickly when an invoice is waiting. Chasing one in January from someone you paid in March is a known misery.

When you must issue a 1099-NEC

You report nonemployee compensation on Form 1099-NEC, due to both the contractor and the IRS by January 31. You must file one for each unincorporated US contractor (individuals, sole proprietors, partnerships, most LLCs) you paid at or above the reporting threshold in the year for business services. The threshold was $600 for many years; legislation passed in 2025 raised it to $2,000 beginning with 2026 payments, indexed for inflation after that — verify the current figure before filing season.

Common exceptions that trip people up:

  1. Corporations (including LLCs taxed as S or C corps) generally don't get 1099-NECs — this is what the W-9's entity checkbox tells you. Attorneys are an exception: legal fees get reported regardless of incorporation.
  2. Payments by credit card or payment platforms (card networks, PayPal business, marketplaces like Upwork) are excluded — the processor reports them on 1099-K instead. If you paid a contractor entirely by card, you typically don't 1099 them. Payments by check, cash, ACH, or wire do count.
  3. Payments for goods aren't reportable — only services.

Bookkeeping that makes January easy

Keep every contractor payment in a dedicated account, with the contractor's name on each transaction. When January arrives, the 1099 exercise reduces to: total the account by payee, drop the corporations and the card-paid, and file for whoever crosses the threshold. Store W-9s alongside your books so the TINs are at hand.

Two further habits: don't mix reimbursed expenses into contractor compensation without noting them (treatment can differ), and never pay a contractor's personal expenses directly — pay invoices. Clean inputs here save real money in accountant time, and real stress in an audit.