If you hire vendors, independent contractors, freelancers, or gig workers and paid them more than $600 in business-related payments, then you’ll need to prepare and issue an IRS Form 1099-MISC so they can file for an income tax return. While it may seem like a complicated procedure to issue these 1099s, it can be pretty straightforward with the right tools and processes in place.
Before we conquer the process, let’s take care of the basics.
What’s a form 1099-MISC?
IRS Form 1099-MISC summarizes income from all non-employee compensation. This is an information return that is filed with the IRS so that the IRS can match vendor payments with the income they report on their tax returns. (Essentially, it’s telling the IRS what you paid contractors throughout the year, and what the contractors will owe as well.)
The 1099-MISC is what independent contractors, small businesses, and any entity that isn’t an S or C-level corporation use to accurately report their income and determine what they will owe. You must send out a Form 1099-MISC to all vendors you’ve hired and paid more than $600 during the year. This includes any partnerships or LLCs you may have contracted.
On top of non-employee compensation, you will likely need to file a 1099 for your rent payments, unless you rent from a property manager. Any rent paid to a business must be noted in a Form 1099.
There are a few exceptions to these rules: You don’t have to send 1099s to most corporations (note: you must send 1099s to all lawyers you’ve hired, even if they’re incorporated), property managers for rent, sellers of merchandise, etc.
The 1099-MISC Form should not be confused with the Form 1099-K, which is required to report third-party networks or vendors that process payments. The 1099-K Form is used to record payments processed through these credit card payment companies, documenting any fees incurred as well.
An independent contractor and anyone employing independent contractors will have to have a Form 1099-MISC to report the gross payments received during the calendar year, and a 1099-K to report any payments made through credit card payment companies. If your employees are all paid via check or any other non-credit card method, you don’t have to worry about form 1099-K.
What’s an Independent Contractor?
Independent contractors are temporary workers who provide goods or services to another company under specified terms outlined in a contract, like an Independent Contractor Agreement. They can be individual workers, companies, or corporations.
Independent contractors are self-employed and typically compensated on a per-project basis, and their employers are not responsible for withholding taxes from their pay.
Instead of receiving a Form W-2 like traditional workers, independent contractors must report the self-employment income information that they receive from a Form 1099. This makes a Schedule C part of their filing process as well.
Because employers don’t have to withhold federal income taxes, state taxes, unemployment taxes, social security, or Medicare taxes for independent contractors, it can be significantly cheaper to hire a freelancer rather than a full-time employee.
But these tax restrictions make it vital for businesses to correctly classify their workers as either contractors or employees. Misclassification can lead to steep IRS fines and penalties. To determine if your worker is an independent contractor or traditional employee, see our 1099 vs. W-2 Calculator.
Are there perks for the Independent Contractor?
As an employer, the perks of an independent contractor are pretty blatant: they’re flexible, cheaper than a W-2 employee, and ideal for short-term or one-off projects. The lack of any employment tax makes them especially appealing for small business owners. But are there any perks for the independent contractor in this relationship? Yes and no.
Downsides for Independent Contractor
A big downside for an independent contractor is that they are technically their own business, and as a result, have to pay self-employment tax on top of all the other taxes employers typically pay.
The other big and more obvious downside is that an independent contractor has to figure out their own estimated tax payments. This can be a little tricky but isn’t impossible if finances are carefully monitored.
Perks for Independent Contractors
An independent contractor will have larger income payments than an equally-paid W-2 counterpart. This is on account of no taxes being taken out, of course. This frees them up to invest more aggressively with their funds if they feel so inclined. In some cases, independent contractors may be looking to launch their own small business, making this quick cash appealing.
While independent contractors are treated as business owners and have to pay self-employment tax, this same sole proprietor status means many things can be written off as business expenses. This includes things like equipment purchased for work, utilities used for work, and even transportation required. This does make end of the year receipt gathering a bit of a mess, however.
Because health insurance isn’t a benefit generally offered to independent contractors by an employer, they’re also more likely to shop for insurance on the market. While this option is available to W-2 workers as well, the temptation of taking company insurance often wins out, meaning they may miss out on potentially smaller health care payments.
Last but certainly not least, another massive perk, despite needing to pay close attention to detail during the tax year and meet numerous reporting requirements: freedom. Every year that an independent contractor receives 1099s is another year they were free to pursue miscellaneous income from other outlets, build their personal brand, and travel around the United States and beyond in many cases.
To any independent contractors out there: Don’t let tax season catch you off guard. Use our free self-employment tax calculator to make sure you’re ready. This will break down your Medicare tax and social security tax, and help you save for your overall tax liability. You’ll still need to consider your filing status, married filing if applicable, child tax credit, head of household status, or any other kind of tax credit you may qualify for.
As an independent contractor it’s also likely you have itemized deductions, but this tax estimator will still help you get an idea of what to set aside so you’re not surprised by your total tax amount.
Is there a deadline for 1099s?
Yes, Businesses must send 1099s to all contractors by January 31st (the same deadline for sending out W-2s). Companies must file those 1099s by the end of February if filing on paper or March 31st if filing electronically.
What’s the penalty for missing the deadline?
The penalty for missing the deadline ranges from $30-$100 per form with a maximum fine of $500,000 per year. If a company completely disregards the requirement to provide a correct statement, it could be hit with a penalty of $250 per form with no maximum.
So how do I prepare the 1099s?
Here are six simple steps to help you prepare your 1099s while adhering to IRS guidelines and filing requirements.
1. Check your work
Before you start the 1099 process, make sure you have all the correct information on your contractors and vendors. You should already have a filled-out Form W-9 for each vendor, which includes their name, address, and Social Security number (SSN) or Employer Identification Number (EIN). The W-9 will also include their tax filing status, so you can check to see if you need to issue a 1099 for that vendor.
It’s a good idea to check with each contractor to see if any information has changed prior to starting the 1099 process. If the contractor has not provided a W-9 or has omitted specific information, the IRS says that you can withhold 28% of the contractor’s pay and send this directly to the IRS. This is known as “backup withholding.”
2. Get your 1099s
Once you have accurate information to work with, it’s time to get your 1099s. You cannot use a downloaded Form 1099-MISC or a sample from the IRS. If you are filing on paper, you’re required to use specific forms that are readable by the IRS scanner used to process all 1099s. You can order these forms from the IRS by calling 1-800-TAX-FORM (1-800-829-3676) or going on their website.
There are also alternative sources for getting these forms. You can order them from some office-supply stores, or you can use financial software like QuickBooks to create, distribute, and file your 1099s online. You can also buy pre-printed 1099 Forms that let you print all of the info from QuickBooks directly into the corresponding sections of the 1099 Form.
3. Fill out the forms
With your contractors’ information and the forms handy, it’s time to start filling them out. Start with your Federal Tax ID number, which could be your SSN or EIN. Then add in the contractor’s information, which includes their SSN or EIN.
Each 1099 should also include the amount of money paid to the contractor, which is entered in Box 7 under the title “Non-employee compensation.” If you withheld any pay from the contractor (e.g. if you had to provide the aforementioned “backup withholding”), you will also need to fill in Box 4 or 11 in relation to any federal or state income tax you withheld.
Finally, confirm that their taxpayer ID is accurate. (This is typically their social security number.). Repeat this for each contractor you’ve worked with. Integrating the 1099 process with your existing financial software means this information is automatically generated and entered for you, saving you time and reducing any potential for human error.
4. Send out the forms
The next part of the process is to send the forms. You must mail or hand each 1099 Copy B to the contractor no later than February 1st. Failure to meet this deadline can lead to the IRS penalty fees mentioned above. It’s essential that these forms are mailed to contractors on time because they need them to make tax payments, report their total amount earned, and ultimately file Form 1099-MISC.
5. Mail form 1096 to the IRS
IRS Form 1096 summarizes the totals from your returns — in this case, from your 1099s. If you file through snail mail, you must mail Form 1096 and Copy A of each Form 1099 to the IRS no later than February 29th. If you’re filing electronically, the forms must be sent out by a hard due date of March 31st.
6. Keep a record of your filing
Be sure to keep Copy C for your own records in case there are questions regarding the information provided to the IRS.
Making tax season with contractors a breeze
Preparing and filing 1099s can be very tedious and time-consuming. While it may seem straightforward, if you employ a number of contractors, the process can quickly become a headache.
Use this article as a guide for the process, but if you get overwhelmed, you should look for help elsewhere. Payroll software like QuickBooks Payroll can help automate the process and save you some time and frustration, and an accountant or tax preparer can also help manage the process.
This article is intended to provide you with the steps for completing and filing these forms; it does not constitute any type of tax advice. For recommendations related to your overall financial and tax status, contact an accountant.