Payroll Basics: How To Identify & Pay Contractors and Vendors

What’s the difference between a contractor and vendor, and how can your small business pay them correctly?

Questions often arise for business owners when it comes to correctly identifying and paying independent contractors and vendors, both of which are non-employee service providers. This article will help you sort through some of the key details.

What is the difference between an independent contractor and a vendor?

The IRS defines independent contractors as individuals who “offer their services to the general public…[where] the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.” Generally speaking, a company that engages an independent contractor tells the individual what the scope of the work is, but does not have control over how the contractor achieves the desired result.  

On the other hand, while it is not a legal classification or an IRS definition, it can be helpful to think of a vendor as an individual or entity that sells a product or service to different customers. Ultimately though, when goods or services are purchased from a third party, labeling the third party an independent contractor versus a vendor really has no significance for purposes of tax reporting. 

In general, if your business pays $600 or more for services performed by someone other than an employee, you will likely need to report the payment using an IRS Form 1099-NEC (or, in limited circumstances, a form 1099-MISC). If the service provider is an LLC, or Limited Liability Company, you’ll report the amount using the LLC’s EIN. An LLC is a way for a service provider to create a business entity in order to have corporate protection — that includes benefits such as avoiding double taxation.

Payments to a service provider may also be reported using an SSN if there is no separate business entity.

What is the difference between an SSN and an EIN?

An SSN is a Social Security Number. SSNs are nine digits (xxx-xx-xxxx) and belong to U.S. citizens and authorized residents.

An EIN is an Employer Identification Number. EINs are also nine digits, but formatted differently (xx-xxxxxxx). To learn more, take a look at our article about SSN and EIN.

Why would a service provider establish an LLC?

LLCs enjoy the protection of a corporate entity, even if it’s a one-person company. This helps protect the individual’s personal assets, and may provide additional tax benefits they wouldn’t get normally as an individual. Some LLC benefits include:

• Separation of personal and company assets

• No double taxation

• Flexible profit sharing

• Less paperwork than other business entities

How do I know which way to pay a service provider and how to report it?

How you pay a service provider depends on whether they have an LLC or use their SSN. The service provider will need to provide your business with a completed IRS Form W-9, and you should use whatever Taxpayer Identification Number (TIN) is provided. 

It’s also important to note that merely labeling someone an independent contractor or vendor does not necessarily make it true. Whether someone is an employee and whether payments to them are subject to employment taxes is a fact-intensive inquiry, which focuses on things like whether the business has the right to control the service provider’s work, financial aspects of the service provider’s work, and the relationship between the service provider and the business. In other words, if you misclassify an employee as an independent contractor or vendor, you may find yourself in trouble with the IRS.

There may be additional factors to consider if you work with independent contractors or vendors who are based outside of the U.S. Other countries may have different criteria for classifying whether an independent contractor or vendor is an employee, so you'll want to make sure you're compliant with the local laws as well as those of your HQ.

Justworks Makes Vendor & Contractor Payments Easy

Paying domestic and international contractors can seem daunting, but there are plenty of tools and software that can help your business get it right. You can easily pay your team, including domestic contractors and vendors, with Justworks Payroll — our simple, lightweight payroll solution.

For businesses in need of a more robust offer, Justworks PEO may be a great fit. Get all the payments features you need, plus access to a suite of modern benefits, HR tools, and compliance support. And now, access our International Contractor Payments feature to pay your people abroad — now available in more than 28 countries.