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Updated: Sep 9, 2022

Paying your contractors on the payroll system used to pay your full-time employees put you at risk.

Many companies choose to pay their contractors from their payroll system, such as Gusto, but this is not recommended! Especially if you are located in CA and NY, one of the first things a proper CFO will do is split contractors out from employees into a different system to derisk your compliance issues.

Separate Contractor Payment System

Consider this situation that frequently occurs — people who were classified as contractors (when supporting your company) apply for unemployment as a W-2 employee after an engagement ends. Typically, only salaried W-2 employees who lose their jobs are eligible to collect unemployment payments (though the CARES Act has temporarily expanded unemployment benefits to freelancers unemployed due to the COVID-19 pandemic). Because your company hasn’t paid into your state’s unemployment insurance from wages withheld from this 1099 contractor, this application for unemployment triggers an audit into your company, and you need to be ready. 

When audited, you need to demonstrate that he/she was clearly a contractor by supplying all the backup documentation, classification reasoning, etc. Using separate employee and contractor management platforms/systems helps support this argument. But this example is not the only situation your company needs to consider — there is always an audit to prepare for, and your contractors/vendors list is one of the first things that is frequently required.

As another example, when you include a research and development (R&D) tax credit on your federal tax returns, you must be prepared for a potential audit. To prepare for this potential R&D tax credit audit, it’s best to have your 1099 workers on a system separate from your W-2 employees. This is because W-2 wages are classified under Qualified Research Expenses (QRE), whereas 1099 payments are classified as Qualified Contract Research Expenses.

A system like Liquid which is designed for independent contractor and vendor management has built-in features to help you with the behavioral, financial, and relationship control factors that determine compliance with independent contractor regulations, including California’s AB5 requirements.

Manage Contractors Like Vendors

Contractors should be treated like your vendors, not employees. Sourcing, onboarding, managing, and paying contractors are different from the typical HR processes for employees. Working with contractors is a complex process, just as it is with vendors. For both contractors and vendors, each work agreement is different – there are different contracts, project setups, rates, payment terms, forms of payment, etc.

Our customers report saving 20 hours per month (on average) when they use Liquid’s complete contractors and vendor management system

Liquid is designed to make contractor and vendor management easy. The platform incorporates simple and efficient onboarding, automated contract and invoice workflows, streamlined payment processing, and more features that help you save time and money.

Independent contractors, consultants, and freelancers all should be engaged through contracts and these contracts should define the scope of the work, any deliverables, etc. The contractors should send you invoices and be paid according to contract-defined terms.

The goal of separating employee and contractor processes and systems is to minimize legal and liability risks to the company, while not putting in place so much process that it becomes overly onerous and restrictive. Utilizing contracts, work orders, and invoices are essential.

Convert to the all-in-one system built especially for you. You need a system that helps organize everything and make life easier. Prevent errors and mitigate compliance risks through one system that has contracts, vendor onboarding work orders, approval process, invoice payments, integrations, and more.

Ready to simplify contractor management? Try Liquid today.



3 min read

Why You Should Not Use Your Payroll System to Pay Your Contractors and Freelancers

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