Small business owners have a number of tasks to complete during tax season, and one important step is providing 1099 forms to independent contractors. You’ll need to identify workers who are contractors, understand the process for completing a 1099-NEC form, and submit the forms properly.
If you’ve provided Form 1099-MISC to contractors in prior years, you’re still in the right place. The new Form 1099-NEC has replaced 1099-MISC to report nonemployee compensation.
Your contractors are valuable workers, and you need to submit accurate tax information on their behalf. The first step is to determine whether each worker is an independent contractor or an employee.
Who is considered an independent contractor?
The IRS provides guidelines to determine if a particular worker is an independent contractor or an employee. This distinction is important because companies do not have to withhold income taxes or FICA taxes (Medicare and Social Security) from an independent contractor’s payments.
Filers who work as independent contractors may request tax withholdings, but the process is not required for all 1099 forms.
To make the determination, business owners consider the following three criteria, which address the degree of control they have over the worker:
- Behavioral control: Does your company have a right to control what the worker does and how they perform the job?
- Financial control: Does your company have a say in the material aspects of a worker’s job? In other words, do you decide which expenses are reimbursed or who provides necessary tools and supplies?
- Contractual relationship: Is there a written contract? Are benefits such as pension, insurance, or vacation days a part of that contractual obligation?
The IRS instructs business owners to look at the entire relationship to determine an independent contractor’s status. The key is the amount of control over the worker.
You can also view this issue from the worker’s perspective. If, in the course of your trade, you have a great deal of autonomy, you’re probably an independent contractor.
Form 1099-NEC reports nonemployee compensation to independent contractors. As of tax year 2020, the 1099-MISC is no longer used to report payments to contractors. However, business owners need to understand when the 1099-MISC form should be issued.
Important requirements for 1099-MISC forms
As you’ll see in the 2020 instructions for both forms, the 1099-MISC reports miscellaneous income, including rents, prizes, and awards. In some cases, a payer (the business owner) is required to follow backup withholding rules for 1099-MISC payments.
According to the IRS, backup withholding is required when a taxpayer (the payee) does not follow these guidelines:
- The payee does not provide the taxpayer identification number (TIN) to the payer for use on information returns, including 1099-MISC forms.
- The taxpayer fails to report prior-year interest income or dividend income on a personal tax return.
If the taxpayer does not follow these filing requirements, the business may be required to withhold 24% on any future payments to the payee. They must then forward withholding amounts to the IRS. This rule is in place to ensure that the IRS collects taxes that are due on income.
You must provide Form 1099-NEC to your contractors each year.
Understanding Form 1099-NEC
A company must provide a 1099-NEC to each contractor who is paid $600 or more in a calendar year. Independent contractors must include all payments on a tax return, including payments that total less than $600. Note also that nonemployee compensation includes payments to individuals and partnerships.
A number of payments do not require a 1099-NEC, including:
- Payments to a corporation, including a limited liability company that is treated as a C corporation or an S corporation for tax purposes
- Business travel allowances paid to employees
- Payments for merchandise, freight, or storage
Payments through third-party networks, including credit card payments, are reported on Form 1099-K. If, for example, a business pays an independent contractor through PayPal, the contractor may receive a Form 1099-K from PayPal for those direct sales. Issuing a 1099-K depends on the number of transactions and the total dollar amount paid.
Use accounting software to fill out a Form 1099-NEC for each contractor, and consult with a certified public accountant (CPA) regarding the 1099 forms your business must provide.
Completing Form 1099-NEC
Here is the information that must be provided on the form:
- Post the nonemployee compensation to box 1 on Form 1099-NEC, and list your company’s taxpayer identification number (TIN) as Payer’s TIN. You’ll also list your firm’s name and address in the top left section of the form.
- List the Recipient’s TIN, name, and address.
- Record any federal and state income tax withholdings, if applicable.
Finally, you’ll see a section to report state income earned and your company’s state tax identification number. The IRS does not require this information, but many businesses include it to make state income tax filings easier for the contractor.
Submitting 1099-NEC forms
When you produce a 1099-NEC, you provide copies of the form to different recipients:
- Submit Copy A to the IRS with Form 1096, which reports all 1099 forms issued to contractors and the total dollar amount of payments.
- Send Copy 1 to your state’s department of revenue.
- Provide Copy B to the recipient (the contractor).
- Keep Copy C for your records; this documents the wage expense that you post on your business tax return.
The due date for producing 1099-NEC forms is on or before the first of February. You must provide a Form 1099-NEC to each contractor and to the IRS by that date. Many businesses e-file, and e-filing makes it easier to meet the filing deadline.
The IRS uses 1099 forms to estimate the amount of taxable income earned by contractors and compares the reported amounts with the contractor’s tax return. The 1099 forms you issue must be accurate so the contractor can file an accurate tax return.
How contractors use Form 1099-NEC
Most freelancers and independent contractors use Schedule C, Profit or Loss From Business, to report self-employment income on their personal tax returns. Here is the process for reporting income earned on a Form 1099-NEC:
- Part 1 of Schedule C reports income earned by the contractor. The total amount earned on all 1099 forms is posted to line 1, gross receipts or sales.
- The subcontractor’s net profit or loss on Schedule C is posted to Form 1040, Schedule 1, as additional income.
- The total adjustments to income on Schedule 1 are posted as income on Form 1040, line 10a.
If any federal income taxes were withheld on a 1099, that total is also reported on Form 1040.
Paying income taxes
Since most 1099 forms do not withhold income taxes, contractors must make estimated tax payments during the year. Check with a tax advisor to find out more about this process.
Working with FICA taxes
Contractors use a different process to pay Medicare and Social Security (FICA) taxes. The net profit on Schedule C is used to calculate self-employment taxes on Schedule SE.
A contractor pays both the employer and the employee share of FICA taxes, which is currently 15.3%. The contractor then deducts the employee portion of the expense (7.65%) on Form 1040.
Making tax season with contractors a breeze
Preparing and filing 1099 forms can be tedious and time-consuming. While it may seem straightforward, the process can quickly become a headache if you employ a number of contractors.
Use this article as a guide for the process, but if you get overwhelmed you should look for help elsewhere. QuickBooks Payroll can help automate the process and save you some time and frustration. Hiring an accountant or tax preparer can also help you manage the process.
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