Most startups rely heavily on contractors and freelancers — especially in the early stages when hiring full-time employees is not practical. A designer here, a developer there, a marketing consultant on retainer. The flexibility is valuable. But the tax compliance side is something many founders underestimate until they get a notice from the IRS.
Here is what you need to know about paying contractors correctly and staying on the right side of your 1099 obligations.
The Basics: Contractors vs Employees
Before anything else, make sure you have correctly classified your workers. The IRS has strict rules about who qualifies as an independent contractor versus an employee, and misclassification carries serious penalties.
In general, a worker is an independent contractor if they control how and when they do their work, use their own tools and equipment, work for multiple clients, and are not economically dependent on your company. An employee, by contrast, works under your direction and control, often exclusively, with defined hours and company-provided tools.
If you classify someone as a contractor when they should be an employee, the IRS can assess back payroll taxes, penalties, and interest. When in doubt, consult your CPA or employment attorney.
The $600 Threshold — What Triggers a 1099
If you pay a US-based contractor more than $600 in a calendar year for services, you are required to issue them a Form 1099-NEC by January 31st of the following year. This includes:
- Freelancers and independent contractors
- Consultants and advisors
- Lawyers (even if paid through a law firm)
- Some service providers
The $600 threshold applies per contractor, per year. If you paid a contractor $500 in Q1 and $200 in Q3, you have crossed the threshold and owe them a 1099.
Important exceptions: Payments made to corporations (Inc. or LLC taxed as an S-Corp or C-Corp) are generally not required to receive a 1099. Payments through credit cards or third-party payment networks like Stripe or PayPal are also reported differently — those platforms issue their own 1099-Ks directly.
For a complete overview of 1099-NEC requirements, see the IRS official guidance on Form 1099-NEC.
Collect W-9s Before You Pay Anyone
The W-9 is the form that gives you the contractor’s legal name, address, and Tax Identification Number (TIN) — the information you need to issue a 1099 at year-end. The critical mistake many founders make is forgetting to collect W-9s upfront and then scrambling to track down contractors months later.
The rule is simple: collect a signed W-9 before making the first payment to any contractor. Make it part of your contractor onboarding process alongside the contract itself.
If a contractor refuses to provide a W-9, the IRS requires you to withhold 24% of payments as backup withholding. That creates complexity you want to avoid.
How to Track Contractor Payments Throughout the Year
The cleanest way to track contractor payments is through your accounting software. In QuickBooks Online or Xero, you can set up each contractor as a vendor, assign payments to the correct expense category, and run a year-end contractor payment report that tells you exactly who to issue 1099s to and for how much.
This connects directly to how you track business expenses overall — contractor payments should flow through a dedicated “Contract Labor” or “Professional Services” category, not miscellaneous or uncategorized.
When your bookkeeper prepares your year-end package, one of the deliverables is a complete contractor payment summary that your CPA can use to prepare and file 1099s on time.
The January 31 Deadline — What Happens If You Miss It
1099-NECs must be filed with the IRS and sent to the contractor by January 31st. Missing this deadline triggers penalties that start at $60 per form for late filing within 30 days, increasing to $120 per form after that, and $310 per form for returns filed after August 1st.
For a startup that paid 10 contractors, missing the deadline by a few months can mean $1,200+ in penalties — entirely avoidable with proper tracking throughout the year.
This is exactly why our year-end financial package includes a complete 1099 tracking summary delivered to you by January 31st — so your CPA can file on time with no scrambling.
Common 1099 Mistakes Startups Make
Paying with personal accounts. If you pay a contractor from your personal bank account, that payment may not show up in your business records. This is another strong reason to keep personal and business finances completely separate.
Forgetting about payments made in December. Year-end is busy. A contractor invoice paid on December 28th is easy to miss when you are pulling together your 1099 list in January. Monthly reconciliation prevents this.
Not issuing 1099s to attorneys. Many founders do not realize that attorneys — even large law firms — require 1099s for payments over $600, unlike most corporations.
Treating equity grants as compensation. If you compensate contractors with equity or stock options rather than cash, the tax treatment is different and more complex. Consult your CPA before doing this.
How Startup Books Handles Your 1099s
Throughout the year, we track every contractor payment as part of your regular bookkeeping. We maintain the W-9 information on file for each vendor and flag any payment that crosses the $600 threshold. When January arrives, we prepare a complete contractor payment summary that your CPA can use to issue 1099s — no scrambling, no missed filings, no penalties.
It is part of what you get when your books are maintained properly all year long. To learn more about what is included in our year-end package, read what we prepare for your CPA at year-end.
Ready to get your books and contractor tracking set up properly? Schedule a free consultation — no contracts, no pressure.