Contractor payroll, explained

Here's the first thing to understand: contractors aren't on payroll. The term "contractor payroll" is technically incorrect, but it's commonly used. Independent contractors are self-employed. They invoice you for services, you pay them directly, and they handle their own taxes. There's no payroll processing, no tax withholding, no benefits administration.

But businesses still need a systematic way to manage contractor payments. You need to track who gets paid what, when, and why. You need records for audits and tax filing. You need proof that payments were made and received. When people say "contractor payroll," they usually mean this workflow—the systematic process for managing contractor payments cleanly and consistently.

This guide explains how contractor payments actually work, the tools you need, typical fees, and the records you must keep. No EOR required.

Employees vs contractors: The payment difference

The distinction matters because it determines how you pay people and what records you keep.

Employees are on payroll. You process regular payments on a fixed schedule (weekly, bi-weekly, or monthly), withhold income taxes and payroll taxes, provide benefits, and use payroll software to manage everything. You issue W-2 forms at year-end. The process is complex and heavily regulated.

Contractors work differently. They invoice you for completed work or milestones. You review the invoice, approve it, send payment through a direct payment provider, and keep records. They handle their own taxes, provide their own benefits, and manage their own business expenses. You issue 1099-NEC forms (for U.S. contractors paid $600+) at year-end. The process is simpler but requires careful organization.

The payment method is fundamentally different. Employees receive regular paychecks. Contractors invoice and get paid for deliverables or milestones, not for time spent.

Why "payroll" doesn't technically apply to contractors

Payroll is a specific legal and financial process designed for employees. It involves calculating gross pay, withholding income taxes (federal, state, local), withholding payroll taxes (Social Security, Medicare), deducting benefits contributions, calculating net pay, and remitting withheld amounts to tax authorities on fixed schedules. Payroll is heavily regulated and requires compliance with numerous rules.

Contractors don't fit this model. They're self-employed businesses. They set their own rates, invoice for completed work, and receive gross payment with no withholding. They handle their own taxes, business insurance, benefits, and business expenses. There's no tax withholding, no fixed payment schedule, no benefits deductions.

When people say "contractor payroll," they're using shorthand for the workflow of managing contractor payments: tracking invoices, approving payments, sending funds, and keeping records. It's payment management, not payroll in the technical sense. Understanding this distinction is important for proper classification and compliance.

The actual payment infrastructure

To pay contractors directly, you need three components: a payment provider, a record-keeping system, and a consistent workflow.

Payment providers send money from your account to contractor accounts. The most common options include:

Wise is best for international contractors. Low fees (0.4-1% on top of competitive exchange rates), real mid-market rates with no markup, fast transfers (1-2 days), and support for 50+ currencies. Contractors receive funds in their local currency. Most cost-effective for international payments.

PayPal is familiar to many contractors and provides instant transfers. Fees are higher (2.9% + $0.30 for domestic, 4.4% + fixed fee for international). Works well for contractors who prefer PayPal and small, frequent payments where the simplicity justifies the cost.

Payoneer is popular with freelancers, especially in emerging markets. Supports mass payouts, charges competitive fees (2-3%), and provides payouts in local currency. Good for batch payments to many contractors across different countries.

Bank transfers via ACH (U.S.) or SEPA (Europe) are often free but slower (2-5 days for delivery). Good for large, infrequent payments where speed doesn't matter and fee savings are significant.

Record-keeping tracks contracts, invoices, payments, and confirmations in a central location. Many businesses use spreadsheets, but contractor management software provides better organization, prevents data loss, and creates audit trails automatically.

Workflow is your process: contractor submits invoice → you review and approve → you send payment → contractor confirms receipt → you log the transaction. Consistency and documentation matter for audits and tax compliance.

Essential records to maintain

Even though contractors aren't on payroll, you still need detailed records. Tax authorities, auditors, and your finance team need proof of what you paid, to whom, and why.

Contracts establish the relationship. Keep copies showing scope of work, deliverables, payment terms, and intellectual property ownership. These documents prove the relationship is contractor, not employee, and become critical if classification is ever questioned.

Invoices from contractors document what they're billing you for. Keep originals showing dates, amounts, descriptions of work, payment terms, and contractor business details. These are your evidence that the payment was for legitimate business purposes.

Payment confirmations prove you sent payment. Keep receipts from Wise, PayPal, Payoneer, or your bank showing the payment was sent, amount, date, and recipient. These receipts are your proof of payment.

Tax forms document contractor status. Collect W-9 forms from U.S. contractors (or W-8BEN from international contractors) before making the first payment. Store these securely as proof you verified contractor status and tax information.

Payment log tracks all payments systematically. Create a spreadsheet or use software to record each payment: date, contractor name, amount, currency, payment method, invoice reference, and any notes. This creates a complete audit trail.

Keep all records for at least 7 years. If you're audited, you'll need to prove every payment was made to a properly classified contractor for legitimate business purposes. Good documentation protects you.

Common mistakes that create risk

Treating contractors like employees. Paying contractors on a fixed schedule (like weekly payroll), setting their work hours, or withholding taxes can trigger misclassification issues. Pay per invoice or milestone, not per pay period. This reinforces the contractor classification.

Not collecting tax forms upfront. Get W-9 (U.S. contractors) or W-8BEN (international contractors) before the first payment. If you pay a U.S. contractor $600+ in a year without a W-9 on file, you can't file an accurate 1099-NEC and may face penalties.

Poor record-keeping. Spreadsheets get disorganized. Emails get lost. Files get misplaced. Use contractor management software to centralize contracts, invoices, and payment records in one searchable location. This prevents records from being lost and makes audits simpler.

Paying without invoices. Every payment needs a corresponding invoice. No invoice means no proof of what the payment was for or that the work was completed. This creates serious audit risk. Always require invoices before processing payment.

Using expensive payment methods. Bank wires cost $25-50 per transfer. PayPal charges 2.9% + $0.30. For a $2,000 payment, that's $58-88 in fees. For international contractors, Wise is often 5-10 times cheaper. Choose payment methods carefully based on amount and frequency.

Mixing contractors and employees. If you have both, manage them in separate systems. Don't mix contractor invoices and employee payroll. This prevents confusion and reduces misclassification risk.

Setting up a repeatable process

Once you establish a system, contractor payments become routine:

Collect everything upfront. During contractor onboarding, collect the contract, tax form (W-9 or W-8BEN), and preferred payment method. Store these centrally.

Establish invoice expectations. Require invoices in a consistent format showing description of work, dates, amount, and payment terms. This reduces back-and-forth.

Schedule regular payment runs. Process contractor payments on the same day monthly (e.g., the 28th). This creates consistency that contractors can rely on and reduces administrative chaos.

Batch similar payments. Group contractors by payment method. Pay all Wise payments together, all PayPal payments together. This reduces processing time.

Always get confirmation. Ask contractors to confirm receipt of payment. Record confirmation date. This proves payment was received and prevents disputes.

Keep one master record. Use a spreadsheet or software to track every payment: date, contractor, amount, invoice reference, payment method, transaction ID, and confirmation date. This is your source of truth for audits and tax reporting.

Year-end tax reporting

At year-end, you need to report contractor payments to the IRS and contractors:

For U.S. contractors: If you paid them $600 or more in the year, prepare a 1099-NEC form showing total payments. File with the IRS by January 31 and send a copy to the contractor. Your payment log provides the data needed.

For international contractors: You typically don't file a 1099. Keep your payment records for your own tax and audit purposes.

Your organized payment tracking makes this process simple. You have the data in one place and can generate reports easily.

The bottom line

Contractors aren't on payroll. They invoice you, you pay them directly using Wise, PayPal, Payoneer, or bank transfers, and you keep detailed records. No payroll software, no tax withholding, no benefits administration.

The key is systematic organization. Track contracts, invoices, and payments in a centralized location. Choose low-fee payment providers based on your contractor locations (Wise for international, ACH for domestic). Keep records for 7 years. Pay per invoice or milestone, not per pay period.

This approach is simpler and cheaper than using an EOR or payroll service. You maintain direct relationships with contractors, control payment timing, and avoid middleman fees. For most businesses working with contractors, it's the right choice.

The investment required is time to set up the system and discipline to follow it consistently. The benefit is clarity, compliance, and control.