What expense category is Subcontractor Costs?

For many businesses, especially in fields like construction, IT, and creative services, hiring subcontractors for specialized labor is a core part of operations. Payments made to these independent professionals—such as electricians, plumbers, or freelance designers—are a necessary and fully deductible business expense.

However, the IRS has very strict rules for classifying these workers. It is absolutely critical for accountants and business owners to distinguish correctly between a subcontractor and an employee, as misclassification can lead to significant tax penalties. This guide will clarify how to categorize subcontractor payments and the essential tax reporting requirements you must follow.

Subcontractor Costs Category

The payments you make to subcontractors for their services are an ordinary and necessary business expense. These costs are reported under the specific category of Contract Labor.

This is a dedicated line item on the Schedule C tax form, designed specifically for payments made to independent contractors for services rendered to your business.

Important Considerations While Classifying Subcontractor Costs

The most critical factor in handling these costs is correctly classifying the worker as an independent contractor and not an employee.

Independent Contractor vs. Employee

This is the most important distinction you will make.

• Independent Contractor (Subcontractor): You have the right to control or direct only the result of the work, not how it will be done. You deduct payments to them as contract labor.
• Employee: You have the right to control what will be done and how it will be done. You deduct their pay as Wages and are responsible for all employment taxes.

As noted in IRS Publication 334 if you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, plus penalties.

Information Reporting on Form 1099-NEC

This is a mandatory compliance step. IRS Publication 334 states that if you pay an independent contractor (an individual, partnership, or LLC not taxed as a corporation) $600 or more during the year for services, you are required to report these payments by filing Form 1099-NEC, Nonemployee Compensation.

Including Parts and Materials

The amount reported on Form 1099-NEC should include payments for services, including any parts and materials used by the subcontractor to perform those services.

Tax Implications and Recordkeeping

To deduct your subcontractor costs, you must report them correctly and maintain thorough documentation.

How to Report the Deduction

For a sole proprietor filing a Schedule C (Form 1040), payments to subcontractors are deducted on Part II, Line 11, Contract labor.

What Records to Keep

You must have documentary evidence to substantiate all subcontractor payments. Your records should include:

• A signed contract or service agreement with the subcontractor.
• Invoices from the subcontractor detailing the work performed.
• Proof of payment, such as canceled checks or bank statements.
• A completed Form W-9, Request for Taxpayer Identification Number and Certification, from each subcontractor. This form is necessary to correctly prepare their year-end Form 1099-NEC.

How Fyle Can Automate Expense Tracking for Subcontractor Costs

Fyle helps you manage and document payments to subcontractors, ensuring every invoice is captured, coded, and ready for tax reporting.

• Centralize Invoices: Forward and attach your subcontractors email invoices to Fyle for automatic and accurate data capture.
• Track by Project: Code every subcontractor payment to a specific job or project for precise cost allocation and profitability analysis.
• Simplify 1099 Preparation: Fyle provides a clean, aggregated report of all payments made to each subcontractor, simplifying year-end 1099 filing.
• Automate Your Accounting: Sync the categorized contract labor expense directly to the correct GL account in QuickBooks, Xero, NetSuite, or Sage Intacct.