Hiring contractors compliantly in the United States
Reviewed by Mellow Editorial Team, HR & payroll content team
Hiring a contractor compliantly in the United States means correctly classifying the worker, using a written agreement, withholding nothing from their pay, and filing a 1099-NEC if you pay them $600 or more in a calendar year. Get any of these steps wrong and you face back taxes, penalties, and potential lawsuits.
Step 1: Confirm the worker genuinely qualifies as a contractor
Classification is the highest-risk step. The IRS uses a behavioral, financial, and type-of-relationship test to determine whether someone is truly independent. Courts and state agencies apply their own tests — some stricter than the federal standard.
Ask yourself:
- Do you control how the work is done, or just the outcome? (Contractors control their own methods.)
- Does the worker set their own hours and use their own tools?
- Can they work for multiple clients at the same time?
- Is the relationship project-based rather than open-ended?
If the honest answer points toward an employee, classifying the person as a contractor exposes you to IRS penalties, back payroll taxes, and state agency audits. When you are genuinely unsure, you can file IRS Form SS-8 to request a determination — though that process takes time and flags the arrangement for scrutiny. Many employers instead consult an employment attorney before the engagement begins.
Step 2: Use a written contractor agreement
A contract does not guarantee independent contractor status in a legal dispute, but it documents the intent of the relationship and sets clear terms. A solid agreement covers:
- Scope of work — specific deliverables, not an open job description
- Payment terms — rate, invoicing schedule, and any milestone-based payments
- Duration — a defined project period or end date, not indefinite
- Intellectual property — who owns work product created during the engagement
- Confidentiality — protection for sensitive business information
- Termination — how either party can end the arrangement
Employment is generally at-will in the United States, but that doctrine applies to employees. Contractor relationships are governed by contract law, so the written agreement is the primary document courts will look at if a dispute arises.
Step 3: Do not withhold taxes from contractor payments
Unlike employees, contractors are responsible for their own taxes. You do not withhold federal income tax, Social Security, or Medicare from contractor payments. The contractor pays self-employment tax (which covers both the employee and employer share of FICA) and makes quarterly estimated tax payments to the IRS on their own.
There is one exception: backup withholding. If a contractor fails to provide a valid Taxpayer Identification Number (TIN) on Form W-9, or if the IRS notifies you that their TIN is incorrect, you are required to withhold a flat backup withholding rate from payments. Collect a completed W-9 before the first payment to avoid this situation.
Step 4: Collect Form W-9 before paying anyone
Form W-9 is the domestic equivalent of an onboarding document for contractors. It captures the contractor's legal name, business name (if any), TIN or Social Security Number, and tax classification (individual, LLC, S-corp, etc.).
Keep the completed W-9 on file. You do not send it to the IRS — it stays with you as the basis for year-end reporting. If a contractor refuses to provide one, apply backup withholding immediately.
Step 5: File Form 1099-NEC for qualifying payments
If you pay a contractor $600 or more during the calendar year, you must file Form 1099-NEC (Nonemployee Compensation). The deadlines are:
- January 31 — send Copy B to the contractor
- January 31 — file Copy A with the IRS (whether paper or electronic)
Payments to corporations (including S-corps and C-corps) are generally exempt from 1099-NEC reporting, with some exceptions such as attorney fees. The W-9 will show you the contractor's classification so you know whether reporting applies.
Penalties for late or missing 1099s scale with how late they are filed and your business size. Filing on time is straightforward if you keep W-9s organized throughout the year rather than scrambling in January.
Step 6: Audit the relationship over time
Classification is not a one-time check. If a contractor engagement stretches beyond its original scope, if you start directing their daily work, or if they stop taking other clients, the relationship may have drifted toward employment. Periodic reviews — especially when renewing or extending engagements — help you catch drift early.
State rules add another layer. California, for example, applies the ABC test, which is significantly harder to satisfy than the federal standard and means many workers who qualify as contractors under federal rules are classified as employees under California law. If you engage workers in multiple states, check each state's classification rules separately.
For employers managing contractors across multiple jurisdictions, how Mellow runs payroll across six countries on one platform covers how the compliance overhead can be centralized without building a separate process for every location.
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