Independent contractor bonus - Key takeaways
Independent contractor's pay is usually specified in the contract agreement. However, you can give a bonus to an independent contractor as long as you include the bonus clause in the contract and follow regulations around tax implications and local employment laws if applicable.
- An independent contractor can receive a bonus from a company.
- Independent contractor agreement must include a bonus clause with criteria and calculation.
- The bonus system must be clearly distinguished between contractors and (full-time) employees.
- Fill in Form 1099-NEC if a contractor has received more than $600 and calculate the total received, including a bonus.
- Bonus clause, when a part of a written contract, is usually legally binding.
- Consider local employment law or tax law if the contractor is foreign.
Summary: Who is an independent contractor?
Independent contractors are workers who offer professional services to companies. They are usually self-employed or small business owners who are contracted to perform services for a period of time, usually on a project basis.
According to the IRS definition, "The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done."
Due to the expansion of remote working, many companies are hiring talent overseas as independent contractors, due to numerous benefits this type of hiring has.
We wrote an extensive independent contractor guide with more details if you need a memory refresher.
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What is a bonus for independent contractors?
In short, a bonus is something you give to a worker to acknowledge their good performance. Bonuses can come in many different forms, but the most common type of bonus is a payment incentive.
Independent contractors are not full-time employees and so they do not receive the usual benefits, so offering them something to recognize their work can be a good idea.
However, keep in mind that sometimes the word "bonus" may sound like something that an employee would receive, so consider calling it a payment incentive instead. This also helps distinguish the bonus system you have for your employees.
Types of bonuses for independent contractors
As we mentioned above, independent contractors can be awarded a bonus (or a payment incentive). Some of the most common types of bonuses include:
- A bonus for completing a project before the deadline
- A bonus for achieving certain project-based goals
- A bonus for exceeding the goals
- A bonus for accepting additional projects, or renewing the contractual agreement
Lookout for misclassification risks:
Independent contractor vs employee
It's very important to understand the legal differences between independent contractors and employees to avoid potential misclassification risks. For every person you hire, regardless of their position, there is a list of obligations you have to follow to stay compliant.
Employment law poses several obligations toward a company hiring employees (full-time or part-time):
- Payment withholding (or payroll taxes) for social security tax, pension plan, medicare, severance packages, business expenses, workers' compensation, and unemployment taxes
- Regular wage
- Employee protection under the Fair Labor Standards Act (FICA)
On the opposite, an independent contractor status doesn't allow for any of the mentioned benefits.
If you are giving your independent contractor a bonus, make sure that the contractor doesn't resemble a full-time employee. The IRS is quite strict when it comes to meeting the criteria of a full-time employee, so you don't want to do anything that will put you at risk.
If you want to give an independent contractor a bonus while protecting your business from potential misclassification risks, always make sure that the independent contractor agreement has a clause about it.
Include a bonus clause in the independent contractor agreement
An independent contractor agreement is a document outlining the working relationship between a company and a contractor). It is a legal document that enables both parties involved to cover the base of their working relationship, avoid misunderstandings, and manage expectations. The independent contractor agreement should also cover the scope of work, deliverables, payments, deadlines, confidential information, and any other details of the relationship.
Read more about the independent contractor agreement and how to create one.
If you decide to give a bonus to your independent contractors, make sure to have a bonus clause within the agreement. Clearly state the criteria and calculation of the bonus, as it will help manage expectations, but also protect you from the potential misclassification risks.
Keep in mind: The independent contractor's compensation must be clearly separated from the bonus. For example, if an independent contractor agreement specifies that they will receive $5,000 at the end of the contract period, a company cannot pay them $3,000 for agreed work and $2,000 as a bonus. Bonuses imply additional compensation beyond the compensation agreed on per the contract.
Other considerations: laws and regulations
An Independent contractor agreement is usually legally binding, meaning that the offer or a promise of a bonus is binding as well. If the written contract explains the bonus criteria and said criteria is met, it is your legal obligation to fulfil it. In case you don't exercise the agreement, a contractor can file a civil suit against you and the company.
If you are hiring contractor's services abroad, it's worth checking the local laws and regulations or seeking legal advice to ensure you are complying with them as well.
Tax from considerations for US companies
As you probably know by now, for each independent contractor who has been paid more than $600 within a tax year, a Form 1099-NEC must be filed. Form 1099-NEC (non-employee compensation) was reintroduced by the IRS for reporting of 2020 tax year, instead of the Box 7 of the Form 1099-MISC.
Learn more about the differences between Form 1099-MISC and Form 1099-NEC here.
This means that if you pay a bonus to an independent contractor, the Form 1099-NEC must reflect the total payment made to the contractor. The total amount being both the compensation and the bonus. If you fail to report this correctly, both you and the contractor are at risk of ax penalties.
If you are working with an independent contractor who has been paid less than $600 within a tax year (including bonus), you don't need to file a Form 1099-NEC.
Giving Bonuses on Deel
If you are using Deel and want to give your contractor a bonus, you can do so directly from the platform. All you need to do is add the bonus amount when you are issuing payment. This tutorial shows how to do that.