Most taxpayers have heard of form 1099, and many receive them, and some produce them for contract employees. This article is for business who hire contractors and the contractors who work for them. Read on to learn what you need to know about Form 1099.
What is a 1099? Difference Between a 1099 and W2 Types of 1099s 1099-NEC or 1099-MISC? What if My Vendor Doesn’t Provide Form W-9? Filing 1099-MISC and 1099-NEC Exceptions: When Are 1099s Not Required Common Problems with 1099s Penalties Related to 1099s
What is a 1099?
A 1099 is what the IRS calls an “Information Return”. That is, a tax return used by the paying party to tell the IRS that they have paid someone. Of course, the IRS wants this information so that they can confirm that recipients are paying their taxes! The IRS will cross reference the 1099s it receives with what is reported on the taxpayer’s return and follow up on any discrepancies. (see our post on IRS Notices). The IRS also shares 1099s with the relevant state authority (except Form 1099-NEC, which is not shared with State tax authorities).
Difference Between a 1099 and a W2
Form W2 is used to report wages paid to employees. The W2 states the amount of income earned, the taxes withheld during the year, other withholding or special payments and information needed to file taxes. A W2 will be generated by each employer regardless of the amount paid.
An individual will generally be considered an employee if the business maintains control over when, where and how they work, pays wages based on time spent working, provides paid time off, employer paid pensions, and insurance or the term of the employment is indefinite and exclusive. It is critical to avoid misclassifying employees as contractors. Employers who make this mistake may subsequently be required to pay both the employee and employer’s portion of FICA and other taxes in arrears. See https://www.irs.gov/newsroom/understanding-employee-vs-contractor-designation for rules explaining when someone must be classified as an employee.
Basically, an employee will receive a W2 and anyone else gets a 1099.
Types of 1099s
Form 1099 is used to report payments made to non-employees for a variety of reasons. The specific 1099 form used depends on the nature of the income. A full list can be found at https://www.irs.gov/forms-pubs/about-form-1099-useful-items. The six most common 1099 forms are the 1099-MISC, 1099-NEC, 1099-INT, 1099-DIV, 1099-G, 1099-K, and 1099-R. (1)
1099-NEC: This form must be filed by businesses that hire self-employed individuals, independent contractors, freelancers, vendors, etc., who receive more than $600 from a single business for services they provide. Learn more here https://www.irs.gov/forms-pubs/about-form-1099-nec
1099-MISC: This form is filed when businesses pay individuals for things other than work or services.
1099-INT: Financial institutions will file this form if they pay an individual more than $10 in interest or more than $600 in business related interest.
1099-DIV: Individuals will receive this form if they receive more than $10 in dividends during the year.
1099-G: 1099-G covers government payments including unemployment compensation, state and local income tax refunds, agricultural payments, or taxable grants.
1099-K: If a business has at least 200 transactions and at least $20,000 in sales processed by a Payment Settlement Entity (PSE) such as a PayPal or most credit card processors, they will receive the 1099-K.
1099-R: if you receive a distribution from a retirement plan (IRS, IRA, or 401(k) exceeding $10 you will need to file this form.
1099-NEC or 1099-MISC?
1099-NEC is a new form for tax year 2020. If you are a business owner and pay someone for their services to your business, and they do not meet the criteria of an employee you may be required to file 1099-NEC. Generally, the following factors result in a filing requirement:
1. You paid someone $600 or more for work done for a business purpose.
2. The work was in the nature of services and not goods
3. The person you paid is not a C or S corporation.
1099-MISC is required for other miscellaneous payments totaling $600 or more to someone who is not a corporation. Examples include:
Royalties (the threshold payment for royalties is $10, not $600)
Rents
Prizes and Awards
Medical and Health Care
Certain Payments to an Attorney
See https://www.irs.gov/forms-pubs/about-form-1099-misc for more details.
What if My Vendor Does Not Provide Form W-9?
Form W9 is used to collect vendor information including the name, address, and tax identification number. This information is needed to prepare and send the 1099. The best policy is to require a W-9 before any work starts or as a condition of payment to the vendor.
If a noncorporate service provider fails to provide a completed W-9 before starting work, consider finding someone else. However, you may proceed with a vendor who refuses but you must withhold a percentage of the payment, called “back up withholding”. The backup withholding rate is 24%. You must report any back up withholding to IRS using form 945 and still file the 1099, with “refused” written where the Tax ID number is supposed to be entered. This scenario also requires paper filing of the affected 1099s. It is much easier to get the W9 up front!
Filing 1099-MISC and 1099-NEC
The easiest way to file 1099s is to use an electronic service. Most payroll services have built in 1099 functionality. Paper filing is an option, but you must use special software to print the forms or order forms from the IRS or office supply store. If you paper file 1099s be sure to also file form 1096.
1099-NEC forms must be sent to recipients AND filed with IRS by January 31st. The deadline to send 1099-MISC to recipients is January 31st. If you are filing by paper, file 1099s with the IRS by March 1. If you are filing electronically, the deadline for filing with IRS is March 31st.
Some states require a copy of the 1099s be filed with their relevant tax authority. Be sure to follow applicable State requirements for preparing and filing.
Exceptions: When Are 1099s Not Required
Here are common situations where a 1099 is not required:
Payments that are not made for a business purpose: You do not have to 1099 people for non-business expense, like repairing your personal car, or painting your personal residence.
Payments made to household employees: at-home babysitters, maids, yard workers are deemed employees by the IRS and should receive W2 unless payments are under the threshold or some other exemption applies. More information can be found in Tax Topic No. 756) https://www.irs.gov/taxtopics/tc756
Payments made to corporations: Payments made to most C-corporations and S-corporations do not trigger requirements to file form 1099.
Payments made by Credit Card or PayPal: Payments made using a Payment Settlement Entity (PSE) do not require a 1099. The PSE will generate 1099-K once these payments reach certain thresholds. Pay Pall Friends and Family service, Venmo and some other payment networks do NOT qualify as a PSE and you will still have to file the 1099 if those options were used to pay. Be sure to check with your service to confirm if they are a PSE or not.
Payments Overseas: If the payment was to a non-US person whose work was completed exclusively outside the USA then no 1099 requirement is triggered. Be sure to confirm with the worker that they are, in fact, outside the United States and confirm that they are not a US citizen living abroad. You must collect form W-8BEN for the worker or withhold 30% of payments if they do not provide it. If you pay a foreign worker who performs the work inside the US, then you must file Form 1042 1042S and withhold appropriate amounts. https://www.irs.gov/forms-pubs/about-form-w-8-ben
Common Problems with 1099s
1. Netting Against 1099-K – often independent contractors will see a portion of their income reported twice: once on a 1099-NEC and again on a 1099-Ks. In other cases, taxable income paid by a PSE will not be reported on the 1099-NEC and also not make it to the 1099-K if the taxpayer is below the reporting limits for 1099-K.
2. Misclassification of Employees – This is one of the most common small business errors: counting employees as contractors. Legislation such as California AB-5 create more differences between State classification purposes and Federal rules, which results in different classifications of the same employees for State purposes and Federal IRS purposes.
3. Late or Missed Filing – Given the proliferation of due dates that vary between Federal and State, type of 1099 an also if the 1099 is filed by paper or electronically it is very easy for due dates to be missed.
Penalties Related to 1099s
The penalty for late filing can range from $50-100 per form. If you have a small business, the penalty maximum is $547,000. If you completely disregard 1099 forms, your penalty will be much higher, at around $270 per form with no maximum.
The information in this article is a general overview. The IRS and State regulations for information returns, including 1099s are complicated and every business situation is different. Talk to your tax professional for specific advice about your unique situation.
Contact Cunningham CPA for questions about 1099 obligations, staying compliant with Federal and State requirements. We can also help resolve compliance issues or disagreements with the IRS and other tax authorities.
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