How do I pay subcontractors vs employees?
Employees get paid through payroll with taxes withheld. Subcontractors get paid the full invoiced amount with nothing withheld. The paperwork, tax deposits, and year-end reporting are completely different for each.
For employees, you need a payroll system. This can be software like QuickBooks Payroll, Gusto, or a similar service. Each pay period, you calculate gross pay, withhold federal income tax, Social Security, Medicare, and state taxes, then pay the employee the net amount. You also owe employer taxes on top of what you withhold. This includes matching Social Security and Medicare, federal unemployment, and New Mexico state unemployment insurance. All these taxes must be deposited with the IRS and New Mexico Taxation and Revenue Department on a schedule based on your total liability. Miss a deposit deadline and penalties add up fast. At year end, you issue each employee a W-2 and file copies with the Social Security Administration by January 31. Getting your payroll system setup done correctly from the start makes all of this run smoothly.
Subcontractors are simpler to pay but require different documentation. Before you pay anyone as a subcontractor, get a completed W-9 form from them. This gives you their legal name or business name, address, and tax identification number. You need this for the 1099 you file at year end. When the work is done, pay the full invoiced amount. No withholding, no tax calculations. They invoice you, you pay them. Keep copies of invoices and proof of payment. If you pay a subcontractor $600 or more during the calendar year, you must issue them a 1099-NEC by January 31 of the following year. File copies with the IRS by the same deadline.
Before deciding how to pay someone, you need to determine whether they are actually an employee or subcontractor. The IRS considers whether you control how they do the work, whether they operate their own business with their own tools and other clients, and whether the relationship is ongoing or project-based. Calling someone a subcontractor when they are really an employee is misclassification. It is common in construction and trades, and the IRS, state agencies, and workers’ comp insurers all audit for it. Back taxes, penalties, and interest can go back years. In New Mexico, misclassification can also create workers’ compensation insurance problems.
Track employees and subcontractors separately in your accounting system. Employee payments run through payroll accounts. Subcontractor payments go to a subcontractor expense account or to a specific job if you are tracking costs by project. This separation makes year-end reporting straightforward and gives you a clear picture of workforce costs. Many virtual bookkeepers in New Mexico can help you set up proper tracking so payments are categorized correctly from day one.
If you have been paying people and are not sure your classification is right, that is worth sorting out before an audit makes it urgent.
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