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What is contractor payroll?

Mar 29, 2021

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Contractor Payroll refers to the tasks a company must execute to ensure temporary W2 Workers and 1099 Independent Contractors (ICs) are paid correctly and on time in accordance with their contract or Statement of Work (SOW).  Contractor payroll is a complex business responsibility that can often appear confusing to employers unfamiliar with the different set of obligations that must be met when paying contractors vs. traditional employees.

Before your organization decides on a payroll model that’s the best option for bringing qualified talent quickly and cost effectively into your contingent workforce, below is a list of critical considerations that will help you on your journey to making an insightful decision:

Contractor payroll: How do I pay contractors?

Contingent workers can go by many different names - contractors, temporary workers, gig workers, contingent labor, Independent Contractors, freelancers, temporary talent or pre-identified contractors; yet they all refer to the same type of non-traditional worker: the contingent worker.

However, depending on the method in which the contingent worker is engaged to perform the work - whether directly sourced through an organization itself or by way of a third party, there exists separate obligations to workers when it comes to how to pay them. 

What's the difference between Temporary W2 workers and 1099 Independent Contractors when it comes to payroll? 

Specifically, a W2 temporary worker is employed by the MSP or staffing firm that engaged that worker, while a 1099 Independent Contractor is self-employed. Many companies in the United States operate a contingent workforce that engages both temporary W2 workers and 1099 Independent Contractors. Below is a breakdown of the differences between the two contingent worker types: 

Temporary W2 Workers 

These types of contractors are typically highly skilled or niche workers who are engaged at companies for specific projects or roles. Temporary W2 workers are contractors who are engaged through a third-party agency such as a Master Services Provider (MSP) or a staffing agency.  

As such, W2 workers are considered to be employed by the third-party and are legally entitled to certain benefits from these organizations as the legal employer of the worker. 

These contractors can count towards the total number of employees the client company employs, as such, these contingent workers are considered when determining if the client company is covered by laws such as the Family Medical Leave Act (FMLA).   

1099 Independent Contractors 

This type of contractor is self-employed and and is not an employee; therefore, companies are not responsible for the withholding, collecting or paying of taxes nor any other payments afforded full-time employees or Temporary W2 workers.  

How to determine whether your workers are contractors or traditional employees 

It's critical that business owners correctly assess whether the individuals providing services are employees or contractors. The determination of whether a worker is an employee or a contractor depends upon whether an "employer-employee" relationship exists between the payer and the payee. 

The ABC test is a guide for employers to use in the determination of if a worker is considered an employee or a contractor in the eyes of the government.  Several states require the use of the ABC test—in part or in whole—to determine the status of workers and employees as it relates to the workforce. 

Ensuring proper classification and taxation of contractors

Engaging contractors and operating a contingent workforce also brings risks associated with unintended co-employment and relationship misclassification. The determination of whether a worker is a traditional employee, Temporary W2 worker or a contractor depends upon whether an "employer-employee" relationship exists between the payer and the payee.   

Co-employment 

Co-employment risk is the term used to refer to situations where two or more organizations exert some level of control over a worker, and are therefore are considered to have employer obligations toward the employee. Co-employment risk can often exist when organizations use staff that are provided by third parties. 

Worker misclassification 

Misclassification happens when an organization incorrectly identifies the relationship that exists between them and the contingent worker. This serious mistake can result in hefty penalties for the company and back payments to the worker.  

Two keys factors involved in making this determination are the amount of control and independence in the relationship. 

As many states are currently under the gun financially with the less than expected tax income, it's predicted that many companies will look to enforcement as a good area to increase this income. Misclassified contingent workers are a prime target for payroll taxes, fees and fines. Having a partner who understands the legal landscape protects you from these unexpected costs.  

Payroll taxes: Employer obligations to Temporary w2 Workers and 1099 Independent Contractors 

Temporary W2 Worker obligations

Many companies outsource the management of their contingent workforce in part or in full to an MSP or staffing agency. As such, the third-party organization is considered the 'employer' and is responsible for payroll processing and tax payments.  

The third party will invoice the client company for contractors' wages, taxes and other administration fees. This invoice is recorded in the company's books and without the obligation to file taxes, compensation insurance or other Human Resources costs.  

Technically, the official employer of a Temporary W2 worker is the third party.

1099 Independent Contractor employer obligations 

Other times, companies will also engage contingent talent independently of a third party, these workers are considered Directly Sourced and must be paid through the company's internal contingent workforce payroll program. 

When operating a contingent workforce payroll program, companies are not responsible for withholding government taxes from 1099 Independent Contractors or providing them with benefits.  

Protecting your contractor payroll program from risk

Depending on your contingent workforce payroll needs, there are various options available to employers, yet there is no scenario that is completely risk free; whichever payroll model your organization chooses to pay contractors, it’s crucial to know the benefits and risks associated with each.

Many organizations choose to outsource their employer responsibilities like contingent workers' payroll to a trusted vendor, like a staffing agency or a Managed Services Provider (MSP), who will manage workers’ payroll as well as provide support during the length of a worker’s assignment(s). Yet, there are still many misconceptions surrounding contractor payroll!

Further to payroll management, the staffing agency or MSP will also identify and implement internal measures to protect the organization from serious risks associated with a contingent workforce and contractor payroll if found in violation of compliance. There are many benefits to outsourcing your contractor payroll; however, penalties for companies found in non-compliance are severe and typically result in fines, penalties and negative employer branding. 

Are you interested in gaining deeper insights into payroll programs?

Download our free case study to learn how we helped one client partner achieve cost savings and more with our tailored contractor payroll solution:Download Case Study

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