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5 Tips for Tracking Independent Contractors in QuickBooks

Although your business might rely on independent contractors just as much as your employees, the government views them as separate entities and as a result, so does QuickBooks. Incorrect setup of independent contractors can lead to reporting errors later that can be time-consuming to fix.

But these all-too-common mistakes can be avoided, if you follow a few simple but important rules. First, you need to make sure you correctly classify your workers. Then, set up QuickBooks to track 1099 data, set up independent contractors as vendors, and track payments to them as bills. At the end of the year, you'll need to report your payments to each independent contractor on Form 1099-MISC, which is located in the QuickBooks Vendors menu. Read the following tips to learn more about independent contractors, how to set them up in QuickBooks, and how to use the software to track them:

  1. Understand how the IRS classifies employees and independent contractors.
  2. Set up QuickBooks to track 1099 data.
  3. Set up independent contractors as vendors in QuickBooks.
  4. Track your payments to independent contractors as bills.
  5. Report payments to independent contractors on Forms 1099-MISC.

1. Understand How the IRS Classifies Employees and Independent Contractors
How a worker is classified will directly affect the withholding and remittance of their Social Security and income taxes, as well as the reporting of their earnings to the government. The IRS states that if you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, plus a penalty. The IRS article "Independent Contractors vs. Employees" discusses the differences between employees and independent contractors, and the importance of classifying them correctly.

QuickBooks also views employees and independent contractors as separate entities. You pay employees with paychecks, withhold taxes for them, and give them a Form W-2 at the end of the year. You pay independent contractors with regular checks, you do not withhold taxes on their behalf, and you give them a Form 1099-MISC at the end of the year.

To determine whether a worker is an employee for purposes of benefits law or tax law, courts apply the so-called multiple-factor common law test. The common law test will help determine if federal, state, and local income taxes should be withheld from the worker and then remitted to the appropriate taxing agency by the employer. The results of the common law test also help determine if an employer must pay federal and state unemployment taxes on a worker's earnings. The key issue in the common law test is the amount of control that the employer has over the worker. Or in other words, how independent the worker is.

Four points in the common law test determine if the worker is an employee:

  • Does the employer have the power to fire or terminate the worker at will?
  • Does the employer provide a place for the worker to work, such as a workbench in a shop or a desk in an office?
  • Does the employer provide the worker with tools, supplies, uniforms, or other items used on the job?
  • Does the employer have a voice and responsibility in what the worker does and how the worker does a job?

If you answer "yes" to all four questions, the worker should be classified as an employee. If you answer "no" to the questions, the worker should be classified in another way, likely as an independent contractor.

The following table illustrates important distinctions between employees and independent contractors:

Employee Independent Contractor
Required to comply with employer's instructions about when, where, and how to work Sets own hours; determines own sequences of work
Hired by the employer Works for other employers; services available to the public
Has a continuous relationship Hired by a leasing company; self-employed
Subject to dismissal; can quit without liability Under contract that governs how the relationship can be severed
Work done personally Permitted to hire assistants
Paid a salary; reimbursed for expenses; participates in company's fringe benefit program Payment by the job; opportunity for profit and loss
Furnished tools, equipment, materials, and training Furnishes own tools, equipment, and training; substantial investment by the worker
Works at the employer's premises Works by the job
Wages and earnings reported on
Form W-2
Wages and earnings reported on Form 1099-MISC
Performs services under the company's name Performs services under the worker's business name

2. Set Up QuickBooks to Track 1099 Data
If you set up your independent contractors as 1099 vendors, QuickBooks can track all 1099-related payments to each vendor. Then at the end of the year, you can use QuickBooks to prepare and print the 1099-MISC and 1096 forms.

You must supply a Form 1099-MISC to any unincorporated vendors (such as independent contractors) who worked for you and to whom you paid more than a specific amount per year. (For the past several years the threshold has been $600, but the amount could change.) You also must file Form 1096, which is a summary of your 1099 forms, with the IRS.

First, make sure you have turned on the 1099 preference, which enables 1099 features in QuickBooks:

  1. From the Edit menu, select Preferences.
  2. In the left menu, select Tax: 1099.
  3. Click the Company Preferences tab.
  4. Next to Do you file 1099-MISC forms?, select Yes.

Then, you need to map QuickBooks accounts to the 1099 categories and set the thresholds for each category. This ensures that QuickBooks can complete your Forms 1099 correctly. You will need to associate an expense account for each 1099 category you report to the IRS, select the QuickBooks account you use to track 1099 vendor payments, and set the minimum (threshold) amount you must report to the IRS.

To assign the correct accounts and set threshold values:

  1. In the 1099 Preferences window, select the appropriate account or accounts for each 1099 category. If you don't, QuickBooks will not fill in the amounts correctly on your 1099 forms. For a list of your accounts, go to the Lists menu and click Chart of Accounts. Note the following:
    • Multiple accounts: You can assign multiple accounts to a 1099 category by selecting Selected accounts in the Accounts column, and then selecting the appropriate accounts in the Select Account window.
    • 1099 category: An account can belong to only one 1099 category. Therefore, the accounts you select should be the same accounts you use to track payments related to your 1099 vendors. For example, if you set up an expense account named "Payments to subcontractors" and you select it to track the 1099 category "Box 7: Nonemployee Compensation," you cannot use this account for any other 1099 category. Typically, accounts associated with the 1099 are expense accounts, but you can also associate other account types with a 1099 category.
  2. Set the threshold value for each 1099 category. Threshold values represent the minimum you must report to the IRS and to the payee for each 1099 category. If you pay an independent contractor less than the threshold, you don't need to file a 1099 form for that person and QuickBooks will not automatically print a 1099 for them at the end of the year. Note the following:
    • Default thresholds: The default thresholds QuickBooks displays are correct as of the date your copy of QuickBooks was manufactured, but the thresholds might change from one year to the next. QuickBooks does not automatically update these thresholds; you must keep track of them yourself and adjust them if necessary.
    • Latest information: To obtain the latest threshold information, visit the IRS Web site at and request a copy of Instructions for Forms 1099, 1098, 5498, and W-2G.

3. Set Up Independent Contractors as Vendors in QuickBooks
When you use independent contractors, you need to set them up as vendors in QuickBooks.

To add a vendor:

  1. From the Lists menu, choose Vendor List.
  2. From the Vendor menu button, choose New.
  3. In the Vendor Name field, enter the name of the vendor as you'd like it to appear on your Vendor list.
  4. If you have an outstanding balance for money that you owe to this vendor, enter the Opening balance and "as of" information.
  5. Enter the information requested on the Address Info tab and the Additional Info tab.
  6. On the Additional Info tab, check the box for Vendor eligible for 1099.
  7. (Optional) Click Next to save the vendor information and enter another vendor name.
  8. Click OK to save the vendor information and close the window.

4. Track Your Payments to Independent Contractors As Bills
Your independent contractors should give you bills or invoices for the services they provide. You then pay your independent contractors the same way you pay any other vendor: by entering and paying bills.

To enter a bill for the work the independent contractor performed:

  1. From the Vendors menu, choose Enter Bills.
  2. In the Vendor field, choose or enter a new vendor.
  3. In the Amount Due field, enter the amount of the bill.
  4. Complete the Ref. No, Terms, and Memo fields as necessary.
  5. In the detail area, assign the bill to one or more expense accounts.
    Important: In order for this bill to show up correctly on this vendor's 1099, you must assign it to the expense account that you specified when setting up your 1099 categories. For instance, if you use "Payments to subcontractors" as the account used to calculate "Box 7: Nonemployee Compensation" in your 1099, then you should assign your vendor payments to this account.
  6. Save the bill.

To pay the bill:

  1. From the Vendors menu, choose Pay Bills.
  2. Select the vendor you wish to pay.
  3. Check to ensure that you are paying from the correct Payment Account.
  4. To pay a single vendor, click Pay & Close. If you're going to make multiple payments, click Pay & New.

For more information, see the topic "Paying independent contractors" in QuickBooks Help.

5. Report Payments to Independent Contractors on Forms 1099-MISC
You must supply a Form 1099-MISC by January 31 to each independent contractor you used during the previous year. You also must send Copies A of all paper Forms 1099-MISC and a Form 1096, a summary of 1099 forms, to the IRS by February 28 (or March 31 if you file electronically). If you have more than 249 vendors for whom you must file 1099-MISC forms, IRS regulations require that you submit the forms electronically. For details, visit the IRS at At this time, QuickBooks does not electronically file 1099 forms.

To prepare 1099-MISC and 1096 forms for your independent contractors:

From the Vendors menu, select Print 1099s/1096, and follow the instructions on the subsequent screens.

Note: You must purchase preprinted forms to print your 1099 forms from QuickBooks. The IRS will not approve a substitute form for filing Forms 1099.

For More Information
For more information about handling independent contractors in QuickBooks 2006 and QuickBooks 2005, see the topic "1099 Overview" in QuickBooks Help.

For more information about handling independent contractors in QuickBooks 2004, see the topics "Adding a 1099 vendor (independent contractor)," "Paying independent contractors," and "Tracking bills vs. writing a check" in QuickBooks Help.

Note: QuickBooks 2006 and QuickBooks 2005 R6 or later offer a new, easier way to find and use your 1099 information. From the Vendors menu, click Print 1099s/1096. The four-step interface will help you ensure that your vendors are correctly set up and guide you through the 1099 printing process.

1099 screenshot
1099 and 1096 Wizard (QuickBooks 2006 and QuickBooks 2005 Only)

The information contained in the QuickBooks Payroll Bulletin is meant to provide general information about the payroll process and is not intended to provide tax or legal advice. Always consult your tax professional when preparing tax documents.

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