Yes, Gusto can pay 1099 contractors, but it works differently than paying regular employees. Gusto offers a dedicated 1099 payment system that handles independent contractors separately from W-2 staff.
Federal law requires that independent contractors receive different tax treatment than employees. The IRS defines the difference based on how much control you have over the worker. When you misclassify someone, both you and the worker face serious penalties. According to recent data, about 35% of U.S. workers now do freelance or contract work. This shift means more businesses need reliable tools to manage 1099 payments correctly.
What You’ll Learn From This Article
đź“Ś How Gusto’s 1099 payment system actually works and what it does differently from W-2 processing
đź’° Real examples showing when you can legally pay someone as a 1099 contractor versus why you must make them an employee
⚖️ The specific tax forms, deadlines, and consequences you face if you get 1099 classification wrong
âś… Step-by-step instructions for setting up 1099 contractors in Gusto and avoiding common mistakes
🚀 State-specific rules that affect 1099 payments and how Gusto handles them across different locations
Understanding 1099 Contractors Versus W-2 Employees
The difference between a 1099 contractor and a W-2 employee matters more than most people think. An employee works under your control and direction, uses your equipment, works your hours, and receives benefits. A 1099 contractor works independently, uses their own tools, controls their own schedule, and handles their own taxes and benefits.
The IRS uses a three-part test to determine proper classification. This test looks at behavioral control (how much you direct their work), financial control (who pays for expenses and tools), and the relationship type (is this temporary or permanent?). If you fail to properly classify workers, the IRS can hit you with back taxes, penalties up to 25% of unpaid employment taxes, and interest charges.
Gusto separates 1099 and W-2 processing because the tax paperwork, payment timing, and reporting requirements are completely different. When you use Gusto for 1099 contractors, the platform generates the right tax forms automatically. This prevents errors that could trigger IRS audits or state investigations.
How Gusto Handles 1099 Contractor Payments
Gusto lets you add 1099 contractors to your account and pay them directly through the platform. You can set up payment information, track how much you’ve paid them, and generate required tax documents. The system stores all contractor information and payment history in one place.
When you pay a 1099 contractor through Gusto, you choose the payment date and amount. Gusto doesn’t automatically deduct taxes from 1099 payments because contractors are responsible for paying their own self-employment taxes. The payment goes directly to the contractor’s bank account, and Gusto creates a digital record of the transaction.
Gusto handles the administrative side by generating Form 1099-NEC (Nonemployee Compensation) at year-end. This form reports how much you paid each contractor and goes to both the contractor and the IRS. The platform calculates totals automatically, reducing mistakes.
The Three Most Common 1099 Contractor Scenarios
| Scenario | What Happens |
|---|---|
| You hire a marketing freelancer for a specific project that lasts 2-3 months | The contractor works remotely, uses their own software, sends invoices, and you pay them through Gusto. They handle their own taxes and insurance. Gusto generates their 1099-NEC at year-end for IRS reporting. |
| You hire a seasonal worker during your busy season, giving them specific daily tasks and schedules | This person might actually be an employee, not a contractor, because you control their work hours and tasks. Misclassifying them costs you penalties. You should use Gusto’s W-2 system instead. |
| You pay a CPA or attorney for a specific consulting project outside their main business | The professional has their own established business, uses their own methods, and works for multiple clients. This is a true 1099 relationship. Gusto tracks the payment and generates the 1099-NEC. |
Real-World Examples: When Gusto Handles 1099 Payments Correctly
Sarah’s Marketing Agency and the Graphic Designer
Sarah runs a marketing agency and needs a graphic designer for a three-month campaign. She finds a freelancer with their own design business, their own equipment, and other clients. Sarah pays the designer $500 per week through Gusto. The designer works from home, sets their own hours, and delivers files according to Sarah’s project needs.
This is a proper 1099 relationship. The designer is independent, has their own business, and works for multiple clients. At year-end, Gusto automatically generates a 1099-NEC showing $26,000 paid to the designer. Sarah files this with the IRS, and the designer reports this income on their tax return.
Tom’s Restaurant and the Kitchen Staff Problem
Tom owns a restaurant and wants to save money on payroll taxes. He tells kitchen staff they’re 1099 contractors instead of employees. He controls their work schedules, requires them to wear uniforms, provides all equipment, and directs exactly how they prepare food.
This is misclassification, and it’s a major problem. The IRS audits Tom and discovers the kitchen staff should have been W-2 employees. Tom owes back payroll taxes, penalties of 25% of unpaid employment taxes, plus interest. One kitchen staff member gets hurt and has no workers’ compensation protection because Tom illegally classified them as a contractor.
Jennifer’s Consulting Firm and the IT Support Contract
Jennifer’s consulting firm needs IT support for their network. She contracts with an IT services company owned by Marcus. Marcus provides the support, handles all equipment and software, serves multiple clients, and charges monthly. Jennifer has no control over how Marcus does the work; she only cares about the results.
This is a legitimate 1099 arrangement. Marcus runs his own IT business and simply provides services to Jennifer. Gusto tracks the payments, and Marcus’s business reports the income. Jennifer receives the 1099-NEC form at year-end for filing.
State Rules That Affect 1099 Contractor Payments
Different states have their own rules about classifying and paying contractors. California uses an ABC test that is stricter than federal law. Under California’s test, a worker is an employee unless the hiring company shows (A) they don’t control the worker, (B) the worker does work outside the company’s normal business, and (C) the worker is independently established in that trade.
New York has specific rules for certain industries. Executive Order 4 requires proper classification for domestic workers, and misclassification has serious penalties. Massachusetts, New Jersey, and Illinois also have strict classification rules that can be tougher than federal law.
Many states require 1099 contractors to register for state business licenses. Some states want you to file the 1099 information with the state tax authority, not just the IRS. Gusto’s state tax features help you stay compliant with these different requirements, but you should research your specific state’s rules.
Setting Up 1099 Contractors in Gusto: Step-by-Step
Adding a Contractor to Your Gusto Account
Log into your Gusto account and go to the Contractors section. Click “Add Contractor” and enter their legal name, Social Security number (or Tax ID), and their address. Gusto will ask for their business name if they operate under a different name than their personal name.
Enter the contractor’s payment method, which is usually direct deposit to their bank account. Gusto requires banking information for contractor payments just like employee payments. You can pay contractors on whatever schedule works for you—weekly, monthly, or per project.
Recording Contractor Payments
When you’re ready to pay a contractor, log into Gusto and find the contractor in your list. Enter the payment amount and select the payment date. Gusto shows you a summary of what will be paid, the payment method, and when it will process.
Review the payment details carefully before you approve it. Gusto tracks every payment you make to that contractor throughout the year. This information automatically populates on the 1099-NEC form that Gusto generates at year-end.
Generating and Filing 1099 Forms
In January of the following year, Gusto creates 1099-NEC forms for all contractors you paid $600 or more. The $600 threshold means you only file 1099s for contractors earning above this amount. Gusto provides copies to you, to the contractor, and files Copy A with the IRS electronically.
You must send Copy B to the contractor by January 31st. Gusto handles the IRS filing for you as part of their tax document service. Make sure contractors have correct mailing addresses so they receive their copies on time.
Handling Corrections and Amendments
If you discover you paid a contractor an incorrect amount or have wrong information on file, you can amend the 1099-NEC. Gusto lets you correct information before January 31st deadline. After January 31st, you need to file an amended return using Form 1099-NEC with “CORRECTED” marked on top.
Amended forms need to be filed with the IRS and sent to the contractor as well. This is why accuracy matters from the start—corrections create extra work and potential audit flags. Gusto’s system helps prevent errors by automatically calculating totals.
Common Mistakes Companies Make When Paying 1099 Contractors
Misclassifying Employees as Contractors
This is the biggest mistake businesses make. You cannot reclassify someone as a contractor just to avoid payroll taxes and benefits. The IRS has specific criteria, and the classification depends on the actual working relationship, not what you call the person.
If you control when, where, and how someone works, they’re an employee. If you provide equipment, training, and ongoing direction, they’re an employee. If you terminate them for any reason without cause, they’re probably an employee. Gusto can help you properly classify workers, but you have to use the right category to begin with.
Failing to Keep Records
You must keep records of how much you paid each contractor and when you paid them. These records need to match the 1099-NEC forms you file with the IRS. If the IRS audits you and your records don’t match your 1099s, you face penalties and increased scrutiny.
Gusto automatically maintains these records in your account, but you should also keep your own backups. Store invoices, payment confirmations, and contracts with contractors. These documents protect you if the IRS questions your contractor payments.
Paying Contractors in Cash Without Documentation
Cash payments leave no paper trail, which creates huge problems if you get audited. The IRS assumes unreported cash payments are income tax evasion. Gusto prevents this by only processing payments electronically through bank transfers.
If you ever paid a contractor in cash and they earned over $600 for the year, you still have to file a 1099-NEC. You need to be able to document those payments. From now on, always use documented payment methods like Gusto to create a clear record.
Not Collecting W-9 Forms
Before you pay a contractor for the first time, you should ask them to complete Form W-9. This form confirms their legal name, address, and tax identification number. Without a W-9, you don’t have verified information to put on the 1099-NEC.
If information on your 1099 doesn’t match what the contractor reports to the IRS, it raises red flags. You protect yourself by getting the W-9 signed before payment. Gusto typically requests this information when you set up a contractor profile.
Missing the January 31st Deadline
The IRS requires 1099-NEC forms to reach contractors by January 31st each year. Missing this deadline means penalties for you and confusion for the contractor. Gusto handles the filing, but you need to make sure all contractor information is correct and complete before year-end.
If Gusto needs corrected information, provide it before Gusto’s deadline for processing. Waiting until late January creates stress and might cause you to miss the deadline. Plan ahead and verify all contractor details in December.
Do’s and Don’ts for 1099 Contractor Payments
| Do | Why This Matters |
|---|---|
| Use documented payment methods through Gusto for all contractor payments | Creates a clear record for IRS audits and shows good faith effort to track payments correctly |
| Collect W-9 forms before paying any contractor | Ensures you have verified legal names and tax IDs for accurate 1099 reporting |
| Verify contractor classification based on the IRS’s three-part test | Protects you from misclassification penalties and ensures contractors are actually independent |
| Set contractors up in a separate Gusto account section from employees | Prevents accidental mixing of 1099 and W-2 data, which could trigger compliance errors |
| Review 1099 forms in January before Gusto files them with the IRS | Gives you a chance to correct errors before they go to the IRS and the contractor |
| Keep copies of contractor invoices, contracts, and payment records for at least three years | Provides documentation if the IRS audits your contractor payments |
| Report all contractor payments over $600 on 1099 forms | Complies with federal law and prevents penalties for unreported payments |
| Don’t | Why This Causes Problems |
|---|---|
| Don’t pay contractors in cash or through untraceable methods | No documentation means the IRS assumes you’re hiding income, triggering audit flags and penalties |
| Don’t classify employees as contractors to avoid payroll taxes | The IRS has strict rules; misclassification results in back taxes, penalties up to 25%, and potential criminal charges |
| Don’t skip sending 1099-NEC forms to contractors by January 31st | Late forms anger contractors, trigger IRS notices, and show you’re disorganized about compliance |
| Don’t use the same payment schedule for contractors and employees | Creates confusion in your records and makes it harder to separate 1099 and W-2 reporting |
| Don’t ignore state contractor classification rules | Many states have tougher rules than federal law; violating them brings state penalties on top of IRS penalties |
| Don’t pay a contractor if you can’t document the business purpose | Vague payments look suspicious; the IRS assumes they might be personal expenses or unreported income |
| Don’t assume all freelancers are contractors | Some freelancers should be classified as employees based on how much control you have over their work |
Pros and Cons of Using Gusto for 1099 Contractor Payments
| Pros | Cons |
|---|---|
| Gusto automatically generates 1099-NEC forms, saving you time and reducing errors | Gusto charges a fee for processing 1099 forms, which adds to overall payroll costs |
| Separate contractor section keeps 1099 and W-2 data organized and easy to track | Limited to contractors only; Gusto doesn’t handle employee misclassification issues once they occur |
| Electronic payments create documented proof of all transactions for IRS audits | You’re still responsible for verifying contractor classification; Gusto won’t stop you from misclassifying workers |
| Gusto handles filing Copy A with the IRS electronically, meeting federal deadlines | Contractor payment features vary by Gusto plan; some plans may have limited contractor capacity |
| Direct deposit for contractors reduces payment errors and eliminates check-writing work | You still need to collect W-9 forms yourself; Gusto doesn’t automatically verify contractor tax information |
| Mobile app lets you process contractor payments from anywhere, anytime | State compliance features require you to research state rules; Gusto provides tools but not legal advice |
Understanding 1099-NEC Forms and IRS Filing Requirements
The 1099-NEC form replaced the 1099-MISC for reporting nonemployee compensation in 2020. This form reports payments to independent contractors, freelancers, and other business service providers. If you paid any single contractor $600 or more in a calendar year, you must file a 1099-NEC.
The form requires specific information: the contractor’s name, address, and Tax Identification Number (TIN); the year of payment; and the amount of compensation paid. Gusto collects this information when you set up the contractor and verifies it matches IRS records. Any mismatches between your 1099 and what the contractor reports on their taxes triggers an IRS notice.
You must file Copy A with the IRS by February 28th (or March 31st if filing electronically). You send Copy B to the contractor by January 31st. Copy C is for your records. Gusto handles Copy A filing electronically, which is always better than paper filing because it reduces errors.
If a contractor requests an ITIN (Individual Taxpayer Identification Number) instead of a Social Security Number, Gusto will accept that as well. This happens with international contractors or those without U.S. citizenship. The ITIN serves the same purpose as an SSN for tax reporting.
If you discover an error on a 1099-NEC you’ve already filed, you file Form 1099-NEC with “CORRECTED” clearly marked at the top. Send corrected copies to the IRS and to the contractor. Keep a copy for your records showing what was corrected and when.
Tax Withholding and Estimated Payments for 1099 Contractors
Here’s something crucial that many businesses get wrong: you never withhold taxes from 1099 contractor payments. Contractors are self-employed, meaning they handle their own taxes. You pay them the full amount they’ve earned, and they’re responsible for calculating and paying self-employment taxes and income taxes.
Self-employment tax is approximately 15.3% and covers Social Security and Medicare. Contractors pay both the employer and employee portions of these taxes because they’re self-employed. They file Form 1040-SE with their annual tax return to report self-employment income and calculate what they owe.
Some contractors make estimated tax payments quarterly throughout the year to avoid a huge tax bill in April. This is their responsibility, not yours. Your job is simply to pay them on time, track the payments, and report the annual total on a 1099-NEC.
If you mistakenly withhold taxes from a contractor payment, you create a serious problem. The contractor reports the full amount they earned on their tax return. You’ve deducted money they’re not supposed to lose. This creates duplicate tax reporting and confuses the IRS.
Gusto’s system doesn’t automatically withhold from 1099 payments, which is correct. If you ever need to withhold for federal backup withholding or state income tax withholding, those are special situations that require specific circumstances. Generally, 1099 contractors receive their full payment amount.
How State Rules Complicate 1099 Contractor Classifications
California’s ABC test is the toughest standard in the nation. All three parts must be satisfied: (A) the contractor doesn’t receive direction and control; (B) the work is outside the usual course of your business; and (C) the contractor is independently established. If you fail any part of the test, the worker must be classified as an employee.
This means a task-based freelancer in California might actually need to be an employee. If you run a tech company and hire a “freelance” programmer to build an app, the app-building work is directly related to your business. The ABC test says this person must be an employee, even though they work remotely and use their own equipment.
New York’s classification rules apply mainly to domestic workers and farm workers, but the state is expanding its focus. Executive Order 4 requires agencies to combat worker misclassification. New York considers workers to be employees unless the hiring party proves otherwise using specific criteria.
Massachusetts treats almost all workers as employees unless they meet strict requirements. The worker must be free from control and direction, work in an independently established trade, and maintain their own business location and equipment. Massachusetts has penalties of up to $5,000 per worker for misclassification.
Illinois, New Jersey, and other states are tightening contractor rules as well. These states have adopted classification tests similar to the ABC standard or are considering them. When Gusto processes 1099 payments, you remain responsible for verifying state-level compliance yourself.
If you have contractors in multiple states, you need to check each state’s rules. Gusto has some state-specific tax features, but you should consult with an accountant or attorney about state classification rules. The stakes are too high to guess about contractor status across different states.
When Gusto’s 1099 System Has Limits
Gusto works well for straightforward 1099 contractor payments, but it has limitations for complex situations. If you hire someone who might be an employee, Gusto won’t make that determination for you. The platform lets you set someone up as a contractor, but the legal classification is your responsibility.
Gusto also doesn’t handle Form 1099-K, which reports payments made through payment processors like PayPal or Square. If you pay contractors through these platforms instead of Gusto, those payments might be reported on 1099-K forms, creating separate filing obligations. This is getting more complex with updated IRS rules for 1099-K reporting.
International contractors create additional complexity. If you pay someone outside the U.S., you might need to handle backup withholding or foreign tax reporting. Gusto has some features for this, but immigration and tax rules for foreign workers require professional guidance beyond what the software provides.
Gusto doesn’t advise you on whether someone should be classified as an employee or contractor. This is a legal determination that requires looking at your specific relationship with the worker. If you’re unsure, you should consult with an employment attorney or accountant before setting someone up as a contractor.
If you misclassify someone as a contractor and Gusto helps you process payments, Gusto won’t protect you from IRS penalties. The company is a tool; you make the classification decision. Using Gusto correctly means understanding your legal obligations first, then using the software to execute them properly.
What Information You Need Before Adding Contractors to Gusto
Before you set up your first contractor in Gusto, gather specific information. You need their full legal name (as it appears on their tax returns), Social Security Number or Tax ID, complete mailing address, and email address. If they operate under a business name different from their personal name, get that too.
Ask the contractor to complete a W-9 form before you start payment. This form confirms their legal name, address, and tax identification. Keeping signed W-9s for at least three years protects you if the IRS audits your contractor payments.
Get their banking information for direct deposit payments. Gusto requires a routing number and account number to process electronic payments. Ask for a voided check if they’re providing this information verbally to avoid errors.
Establish the payment terms upfront. Will you pay per project, hourly, daily, weekly, or monthly? Create a simple written agreement stating the payment amount, payment schedule, and the work scope. This written document is evidence of an independent contractor relationship if questions arise later.
Collect emergency contact information just like you would for employees. Even though contractors aren’t employees, you might need to reach them quickly if issues arise. This is basic business practice.
Year-End Processes and Deadlines for 1099 Reporting
The year-end reporting process starts in December when you should review all contractor payments. Log into Gusto and verify that you’ve recorded all payments correctly. Check that contractor information—names, addresses, and tax IDs—is accurate and matches what they provided on their W-9 forms.
January is when Gusto generates 1099-NEC forms. Review each form carefully before filing. Check that payment totals are correct and match your records. If you spot errors, Gusto lets you make corrections before the filing deadline.
Copy B must reach contractors by January 31st. Gusto can mail these automatically or you can distribute them yourself. Make sure the contractor’s current address is correct to avoid return mail and compliance issues.
Copy A goes to the IRS electronically by February 28th (March 31st for electronic filing). Gusto handles this automatically as part of their service. Once the IRS receives the form, you’ve met your federal reporting obligation for that contractor.
Keep records of all contractor payments, 1099 forms sent, and filing confirmations for at least three years. The IRS can audit payroll records from prior years, and you need documentation to defend any contractor payments you’ve reported.
Comparing Gusto’s 1099 Features to Other Payroll Software
Most payroll software companies now offer 1099 contractor payment options because the market demands it. Gusto’s contractor features are straightforward and integrated with their main payroll system. This integration is helpful if you have both employees and contractors.
QuickBooks Online also handles 1099 payments but focuses more on invoicing and expense tracking. If you already use QuickBooks for accounting, their contractor tools might feel more natural. However, QuickBooks is primarily accounting software, not payroll software like Gusto.
ADP and Paychex are enterprise-level payroll solutions with robust contractor management, but they’re expensive for small businesses. These platforms are built for companies with hundreds of employees and many contractors. For small business needs, Gusto is usually more affordable and easier to use.
Rippling combines payroll, benefits, and HR management with contractor payment options. Rippling’s strength is its unified employee database, but contractors don’t integrate as smoothly as in Gusto. For companies hiring mostly contractors, Gusto might be simpler.
OnPay is another small-business payroll option with contractor support. OnPay is less expensive than Gusto in some cases, but has fewer features and less intuitive design. Your choice depends on budget, the number of contractors you hire, and how much automation you value.
The right software depends on your specific needs. If you have mostly employees with occasional contractors, Gusto works well. If you have mostly contractors with few employees, you might need different software. Compare your situation against each platform’s strengths.
FAQs
Can Gusto process 1099 payments to international contractors?
Yes, but it’s complicated. Gusto can process payments to contractors outside the U.S. if they have a valid taxpayer identification number or provide tax information. However, you may need to handle additional tax withholding or filing requirements depending on the country and your business structure. You should consult a tax professional about international contractor payments.
What happens if I pay a contractor less than $600 in a year?
No, you don’t file a 1099-NEC for contractors earning under $600. However, you should still keep records of all payments. If the same contractor earns over $600 in a later year, you’ll need to file then. Some states have lower thresholds, so check your state’s rules as well.
Can I pay multiple contractors at once in Gusto?
Yes, Gusto lets you process batch payments to multiple contractors in one session. You’ll enter each contractor’s payment amount separately, then confirm the batch before processing. This saves time if you pay many contractors regularly.
What do I do if a contractor refuses to provide their Social Security Number?
They must provide a tax identification number for you to report the payment. They can provide an ITIN instead if they don’t have a Social Security Number. If they refuse both, you cannot legally pay them through Gusto without violating tax law.
Does Gusto automatically know if someone should be an employee instead of a contractor?
No, Gusto doesn’t verify contractor classification. You must determine whether someone is truly an independent contractor based on the IRS three-part test. Gusto is a tool; it doesn’t provide legal classification guidance. Consult an attorney if you’re unsure.
What if I accidentally miscalculate a contractor’s payment before submitting it?
You can edit the payment amount before Gusto processes it. Once the payment goes through, you would need to make a separate adjustment or new payment. Always double-check amounts before confirming payments.
Can Gusto handle backups withholding for contractors?
Yes, but it’s a special situation. Backup withholding applies when a contractor fails to provide a tax identification number or the IRS notifies you of a mismatch. Gusto can process these withholdings, but you need specific IRS instructions first.
What if a contractor moves to a different state during the year?
Update their address in Gusto before year-end. The address on the 1099-NEC should be their address as of the last payment date, or their address on record at year-end. Correct addresses help ensure they receive their copy of the form and avoid IRS notices.
Do I need to send 1099 forms to contractors who request electronic copies instead of paper?
Yes, you can send 1099 forms electronically if the contractor agrees. Get their consent in writing first. Electronic delivery must get to them by the same January 31st deadline as paper forms.
Can I use Gusto to classify someone as a contractor temporarily and switch them to employee later?
Yes, you can change someone’s classification in Gusto. However, you cannot reclassify retroactively for payments you’ve already made. If you’ve been paying someone as a contractor for a year and should have made them an employee, you face back tax and penalty issues. Get classification right the first time.
Does Gusto handle state 1099 filing requirements automatically?
Partially. Gusto files federal 1099-NEC forms for you, but state requirements vary. Some states require separate 1099 filings; others don’t require 1099 filing at all. You need to check your state’s specific rules and handle state-level filings separately if required.
What if a contractor claims their payment amount is wrong?
Review your Gusto records and the payment confirmation together. If you made an error, you can issue a corrected 1099-NEC marked “CORRECTED” on the form. If the contractor is mistaken, provide them with documentation of the actual payment made through Gusto.
Can I deduct contractor payments as a business expense?
Yes, payments to contractors are generally deductible as ordinary and necessary business expenses. However, the contractor must be legitimately independent and performing actual work for your business. Payments that don’t have clear business purpose or go to individuals you don’t actually hire may trigger IRS questions.
Do contractor payments factor into my payroll tax deposits?
No, 1099 contractor payments are separate from payroll taxes. You pay payroll taxes only on employee wages. Contractor payments don’t reduce your payroll tax obligation because contractors don’t qualify for unemployment insurance or workers’ compensation through your business.