Many small businesses hire short-term or bring on independent contractors to complete projects. Properly accounting for expenses associated with their work is mission critical.
You can track these expenses and file 1099-MISCs for your independent contractors directly from QuickBooks. It’s essential that you follow the process outlined in this article, not only for good accounting but legal reasons as well. There are also hired-wired 1099 features that only work up if you utilize these workflows.
Why do I need to track 1099 independent contractor payments separately?
The very simple answer: separating regular employee payments from independent contractor payments is crucial due to the nature of their work and their relationship to your business.
Independent contractors, on-demand or self-employed workers, and freelancers are individuals who do work for you but are not your official employees. As such, you need to report independent contractors’ “non-employee” compensation on the 1099-MISC. Thus, from financial and legal standpoints, the difference needs to be made abundantly clear.
There are additional stipulations for what constitutes as non-employee compensation. Moreover, knowing whether someone who works for you should (or should not) be classified as an independent contractor can be tricky. If you are unsure, reach out to a tax professional or refer to the legal source of truth on the matter, the IRS website.
Intuit regularly updates this handy 1099 or W-2 Calculator (a W-2 is the tax form you file for your regular employees). This tool does not constitute true legal advice, but it will give you a rough idea of what differentiates these two types of workers.
Get started adding 1099 contract workers and tracking their expenses
The Workers Tab is where you create and manage records for your regular employees and independent contractors. In QuickBooks Online, independentcontractorsarecategorizedasVendors. While this might seem odd at first, just like a product vendor, they are individuals you owe money to. There are two ways to add independent contractors:
Add an independent contractor as a Vendor
This is the “old method.” It works well if prefer manually adding tax information on behalf of your independent contractors (instead of sending a request asking them to fill out their tax information). This is also the method you’d use if you need to start tracking a vendor with an existing account as an independent contractor.
Let’s assume we’re creating a brand new record for the contractor. To start, go to the Expenses tab, click the Vendors sub-tab and click New Vendor.
You’re probably quite familiar with this screen, so proceed with filling out their financial information per the usual method. At the bottom of the screen, if you know the contractor’s Employer Identification Number (EIN), enter it on the Business ID No. line. Without this number, they won’t show up on the 1099 module. You can add this number later, just remember to do so before it’s time to file. Check the box that says “Track payments for 1099” and QuickBooks will add the independent contractor to the tax filing module.
When you go back to the Workers Tab and click the Contractors sub-tab, you will see your new independent contractor on the list.
Before going any further, click on your new contractor’s name and make sure all the information is correct, most importantly their EIN and email address if you plan to send their 1099-MISC electronically.
If you need to make any edits, click the Pencil Icon.
Important - You can use this exact same process to track an existing vendor for a 1099-MISC. Instead of creating a new account, edit their profile, but keep in mind that you will have separate the expenses associated with products and services you buy from the vendor from the expenses related to their contract labor.
This will mean being very deliberate about which account you map expenses to on Expense forms.
Add an independent contractor from the Workers Tab
This new workflow was introduced alongside the Workers Tab and offers a key benefit – you don’t have to collect tax information from your independent contractors beforehand. Instead, they can provide their EIN, SSN, and other pertinent information to you via secure message.
Head over to the Workers Tab and the Contractors sub-tab. Click Add a Contractor and you will see the prompt below:
Fill out the form and send the request. When your contractor has completed the form, their profile will update automatically.
Important- If you plan to add contractors with this method, double-check the information they provide. Since you’re filing their 1099-MISC, you’re responsible for managing this information. Make requests sooner rather than later so you have enough time to go over what’s on file with your contractors.
Set up a new Expense Account to track Independent Contractor Expenses
Now we create an expense account for payments made to independent contractors. This step is especially important for vendors you also buy products and services from. Expenses for products and services need to be clearly differentiated from the work they do as an independent contractor.
Open from the Accountingtab and go to your Chart of Accounts. Create a new account like the one pictured below:
Name the account “Independent Contractor Labor” or something that makes sense to you and is easy to remember
Select “Expenses” as the Account Type and “Cost of Labor” as the Detail Type
From now on, every time you enter an expense or pay a check to your independent contractors, map those transactions to this new Expense account.
This is how you separate transactions related to independent contractors from other sources/types of expenses.
Show me why I should track Independent Contractors this way
I want to add two independent contractors, one who already has a Vendor profile and one who does not. I start with the independent contractor who isn’t in my system. I go Workers Tab > Contractors > Add a Contractor and see the message below:
If I use this method to add contractors, I need to set a reminder to double-check what they entered later on.
In this scenario, I prefer to add their information myself. I go to Expenses > Vendors > New Vendor, fill out their information and check the “Track payments for 1099” box.
From the same tab, I find the second contractor who already has a Vendor profile. I click on their name and “edit” their profile page. All I have to do is check the “Track payments for 1099” box. When I go back to the Contractor Tab, I see both entries.
To finish up, I make sure all of their labor costs are mapped to my “Independent Contractor Labor” Expense account so I am ready to input this data when I prepare their 1099-MISCs.
Preparing 1099-MISCs for Independent Contractors
At the end of the year, these independent contractors will automatically show up on the Prepare 1099s module (accessible from the Vendors and Contractors sub-tabs). Moreover, since I’ve been tracking their payments exclusively with the “Independent Contractor Labor” Expense account, filing the 1099-MISCs will be a breeze.
On Step 2 of the Prepare 1099s module, select Box 7: Nonemployee Compensation. Choose the account you used to pay your contractors (in the example case, the account is called “Contractor Payments”). This tells the IRS what money was used for non-employee compensation.
On Step3, the Vendors you started tracking will automatically appear on the list. If you don’t see one of your contractors, simply edit their profile using the steps above. Complete the module and you’re ready to send out 1099-MISCs to your independent contractors.
Any other tips I should keep in mind to be successful?
Always be cognizant of which Expense account you’re using when you enter expenses related to independent contractors.
Use the memo and description fields to further document what these types of expenses are for so you won’t have to guess during the rush of tax season.
If you already entered labor expenses for a Vendor into a different expense account before going through this process, go back and recategorize those transactions into the new “Independent Contractor Labor” account.