How to Pay Subcontractors

Paying a subcontractor looks simple enough on paper. You agree on a price, do the work, and send the money. But knowing how to pay subcontractors correctly means more than sending a check or a Venmo payment. There are compliance steps that happen before the first dollar ever changes hands and reporting obligations that come due months later. Skip them, and you may face IRS penalties, backup withholding headaches, or a worker misclassification audit.

This guide is for general contractors, small business owners, freelancers who hire help, and project-based businesses. It goes through the entire payment process, from confirming the working relationship to filing the appropriate tax forms at year-end, ensuring every detail is accounted for.

Step 1: Confirm the Worker Is a Subcontractor, Not an Employee

Before you discuss rates or payment schedules, you need to be sure the person you're hiring actually qualifies as a subcontractor under IRS guidelines. Misclassifying a worker is one of the most expensive mistakes a small business owner can make. It can trigger back taxes, penalties, and interest owed on employment taxes you never withheld.

The IRS looks at three main factors: behavioral control (do you direct how the work is done?), financial control (do you control how the worker is paid and whether they work for others?), and the type of relationship (is there a written contract, employee benefits, or an indefinite arrangement?). A true subcontractor typically sets their own hours, uses their own tools, and works for multiple clients.

For a deeper breakdown of where the line falls, see our guide on contractors vs. employees. Getting this right before any payment discussion protects you from downstream liability.

Step 2: Collect a W-9 Before the First Payment

A W-9 is the form that captures the information you'll need to file a 1099-NEC at year-end. Collect it before the first payment, not as an afterthought in December when you're scrambling to file.

If a subcontractor refuses to provide a W-9 or provides incorrect information, you may be required to apply backup withholding at 24% of each payment and remit it to the IRS. The W-9 stays in your files; you do not send it to the IRS.

Make W-9 collection a standard part of your subcontractor onboarding. Treat it the same way you'd treat a signed contract: required before any work begins.

Step 3: Set Clear Payment Terms in a Written Agreement

A handshake deal is hard to enforce and nearly impossible to document when tax time arrives. A written agreement protects both parties and removes ambiguity about what was promised.

Your contractor payment terms should cover:

• Payment amount or rate (flat fee, hourly, or per milestone)

• Payment schedule (upon invoice, weekly, monthly, or at project completion)

• Accepted subcontractor payment methods

• Invoice submission requirements and due dates

• Late payment terms or penalties

• Retainage terms, if applicable (common in the construction industry)

The agreement should also state explicitly that the subcontractor is responsible for their own self-employment taxes. This won't change the IRS's analysis of the relationship, but it sets clear expectations and reduces disputes. Verbal agreements create recordkeeping problems and offer little protection if a payment dispute ends up in court or triggers an audit.

Step 4: Choose a Payment Method

Once the paperwork is in order, the payment method comes down to speed, cost, and how well it documents the transaction. There's no single right answer; the goal is to match the best method to your situation.

You should never pay contractors in cash. Cash payments to subcontractors for completed work are legal under federal law, but they're nearly impossible to document in a way the IRS will accept. Undocumented cash payments can be a focal point during an IRS audit.

It's important to keep in mind that if you pay a subcontractor through a credit card or third-party payment network, the payment processor typically reports those payments on IRS Form 1099-K rather than you reporting them on Form 1099-NEC. This is a common source of confusion. There are usually payment processing fees associated with this type of payment.

Step 5: Document Every Payment

Documentation is not optional. For every payment you make to a subcontractor, record the date, amount, payment method, and the purpose of the payment. Invoices from the subcontractor serve as your primary documentation and should be requested for every transaction, not just larger ones.

Dedicated software makes this significantly easier. When payments are logged automatically alongside invoices, you're not piecing together records at year-end from business bank account statements and email threads.

Businesses that work with a dedicated accounting team can track payments to contractors as part of their ongoing financial records. 1-800Accountant's full-service bookkeeping solution does exactly that, so when January arrives, the data needed to file 1099-NEC forms is already organized. For a walkthrough of what comes next, see our guide to issuing a 1099.

Step 6: File a 1099-NEC If the Payment Threshold Is Met

There are 1099-NEC requirements once a threshold is triggered. If you paid a subcontractor $2,000 or more in 2026 for services (The IRS reporting threshold in 2025 was $600), you are generally required to file a 1099-NEC with the IRS and provide a copy to the subcontractor. This applies to sole proprietors, single-member LLCs, partnerships, and S corporations paying independent contractors for services rendered.

Per IRS guidance on subcontractors, the reporting obligation covers payments for services in the course of your trade or business. Personal payments don't count, but any business-related service payment at or above the threshold does.

A few important nuances about 1099-NEC filing:

• Corporations are generally exempt. If the W-9 shows the subcontractor is a C corp or S corp, you typically don't need to file a 1099-NEC. The W-9 entity type field tells you this.

• Payment processor exception. When a subcontractor is paid via credit card, PayPal, Stripe, or a similar platform, the processor typically reports those payments on IRS Form 1099-K. In those cases, you wouldn't file a 1099-NEC for the same payments. Mixing these up is a common mistake.

• The $2,000 threshold is cumulative. It applies to total payments to a single subcontractor across the full calendar year, not per invoice.

For a broader look at the different forms involved, see the types of 1099 tax forms. To understand what's at stake if you miss the deadline, this breakdown of penalties for missing 1099 forms is worth understanding ahead of the January deadline.

Common Mistakes to Avoid When Paying Subcontractors

Even business owners who know the rules can slip up sometimes. Here are the errors that most often create IRS problems or payment disputes:

1. Skipping the W-9 form for subcontractors until tax season. By the time you need to file, it's too late to fix backup withholding issues retroactively.

2. Misclassifying an employee as a subcontractor. The IRS has specific tests, and getting this wrong means paying back payroll taxes plus penalties.

3. Paying in cash without documentation. No paper trail means no proof of payment if questions arise.

4. Assuming payment apps eliminate the 1099-NEC requirement. The platform may issue a 1099-K, but that depends on how the payment clears. When in doubt, verify.

5. Missing the January 31st filing deadline. Penalties start at $60 per form and increase the longer the filing is delayed.

6. Failing to keep copies of signed agreements and invoices. These are your primary defenses in the event of a dispute or audit.

Pay Subcontractors the Right Way

Knowing how to pay subcontractors correctly protects your business from IRS penalties and payment disputes. The process starts before the first payment with a W-9 and a written agreement, continues through accurate documentation of every transaction, and ends with a 1099-NEC filing in January if the threshold is met.

As your business grows and you bring on more subcontractors, the recordkeeping and filing obligations add up quickly. Ensure 1099 filing and payment tracking are accurate and up to date with professional year-round accounting support from 1-800Accountant. Get started with 1099 Tax Form Filing, so you can always have confidence in the accuracy and timeliness of your reporting.