This article will give you the basic information needed to properly report payments to independent contractors to the IRS, Form 1099 miscellaneous filing requirements, backup withholding and how to avoid being liable for it, and CP2100 backup withholding notices for payee name, in tax for identification number, or mismatches.
What is an Independent Contractor?
It is critical that you correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment taxes on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors. Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be an independent contractor. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. The person performing services may be an employee. Under common law rules, anyone who performs services for you is your employee if you can control what will be done and how it will be done. What matters is that you have the right to control the details of how the services are performed. To determine whether the person providing the service is an employee or independent contractor, all information that provides evidence of the degree of control in independence must be considered.
Common Law Independent Contractor Test
The common law rules that provide evidence of the degree of control and independence are divided into three categories. One is behavioral. Does the company control, or have the right to control, what the worker does and how the worker does his or her job? Two is financial. Are the business aspects of the worker’s job controlled by the payer? These include things like: how is the worker paid, whether expenses are reimbursed, or who provides tools and supplies, et cetera. Finally, three, the type of relationship: are there certain contracts or employee-type benefits, such as a pension plan, insurance, vacation pay, et cetera? Will the relationship continue and is the work performed a key aspect of the business? Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. The keys are to look at the entire relationship, consider the degree or the extent of the right to direct and control. And finally, document each of these factors used in coming up with a determination.
If after reviewing the categories of evidence, it is still unclear to you whether a worker is an employee or independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, can be filed with the IRS. Either the business or the worker may file Form SS-8. If the worker files the form, the IRS will follow-up with the firm to get the firm’s views as well. IRS will review the facts and circumstances and officially determine the worker’s status
Reporting requirements for payments to independent contractors- Forms 1099
There are many kinds of Form 1099. But for this presentation, I will be exclusively talking about Form 1099-MISC. Form 1099-MISC is most commonly used by payers to report the payments made in the course of a trade or business to others for services. If you paid someone who is not your employee, such as a subcontractor, an attorney, or an accountant, $600 or more for services provided during the year, the payment might need to be reported on a Form 1099. You must provide Form 1099 to the independent contractor by January 31st of the year following the payment.
You must also send a copy of this form to the IRS by February 28th, although the form does not have to be filed with the IRS until March 31st if your business files their 1099s electronically. You may have to file Form 1099 to report payments for services performed for your trade or business if the following four conditions are met. One, you made the payment to someone who is not your employee. Two, you made the payment for services in the course of your trade or business, including government agencies and non-profit organizations. Three, you made the payment to an individual, a partnership, a state, or in some cases a corporation. And four, you made payments to the payee of at least $600 during the year.
How are Payments to Independent Contractors Report to IRS?
Generally, you report a payment as a Non-Employee Compensation. Payments for services to corporations generally are not required to be reported on Form 1099 unless those payments were for legal or medical services. However, payments for services to partnerships are required to be reported on Form 1099. A common mistake is failing to issue Form 1099 to a limited liability company or LLC. An LLC is a business structure allowed by state statute. Depending upon elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, a partnership, or as part of the LLCs owner’s tax return. Payments for services to LLCs must be reported on Forms 1099 unless the payee has elected to be treated as a corporation for federal tax purposes. It’s important to properly complete Form 1099 in order to avoid backup withholding and penalties, which will be discussed later. Be sure to complete the payer’s – that’s your name and address; the payer’s Federal identification number; the recipient’s identification number; the recipient’s name and address; and, in Box 7, the amount paid to the independent contractor. Your business is only required to secure the payee’s TIN when the payment becomes a reportable payment; that is, generally when the total payments in a calendar year exceeds $600.
Form W-9, TINs, and other Identifying Information for Taxes
Form W-9, Request for Taxpayer Identification Number and Certification, can be used to request the correct name and TIN of the payee; but it’s not required at this point. A TIN may be either a Social Security number, or an SSN, or an Employer Identification Number or EIN. You can secure the payee’s TIN in any manner, written or orally. If you do secure the payee’s TIN using Form W-9, keep the Form W-9 in your files for four years for future reference and in case of any questions from the payee or from the IRS. What should you do if a payee doesn’t provide or refuses to provide you their TIN? You, as the payer, should initiate backup withholding.
What is backup withholding?
“What is backup withholding?,” you might ask. Under the provisions of Internal Revenue Code, Section 3406(b), persons making certain payments to payees must withhold and pay to the IRS a specified percentage of those payments under certain conditions, including payments to independent contractors. Publication 15 includes a listing of other types of payments that may be subject to backup withholding. Backup withholding is also applicable if a payee provides you with an obviously incorrect TIN. An obviously incorrect TIN is one that contains more or less than 9 digits or contains alpha characters, say, letters. If a payee does not provide you with his or her TIN, you as the payer are required to withhold 28% from the payment as backup withholding. If the IRS discovers that you, the payer, did not withhold the required backup withholding, you can be held liable. You report backup withholding on Form 945, Annual Return of Withheld Federal Income Tax. For more information, including the deposit requirements for Form 945, see the instructions for Form 945 or Publication 15.
What if a company pays cash to an independent contractor; does that need to be reported?
Yes, the method of payment is not dependent upon whether a taxpayer business is required to file a Form 1099. Whether a business pays in cash or by check or by credit card, if they make a payment to an independent contractor that exceeds $600, they are required to file a 1099. So again, the method of payment is not the criteria. It is the amount of the payment that is the criteria.
What if someone is paid $500 for one job, and later this company pays the same person $500 for another job? Those are both under $600. So does a Form 1099 have to be issued or does it not?
That’s a good follow-up question because it’s important to understand that it’s not just the payment for each specific job. If you have an independent contractor that is performing separate jobs throughout the year, a business determines whether a 1099 is required to be filed depending upon the total payment that’s made during the year. So in that case, since the total payment would be $1,000 — $500 for the first job and $500 for the second job – the business would be required to file a 1099. But it’s important to note that if the first $500 payment, that payment would not, in and of itself, be a reportable payment. So the business would not be required to have secured the payee’s TIN at that point. But when they made the second $500 payment, that put them over the $600 threshold. So if the business did not have the payee’s TIN at the time they made the second payment of $500, they would be required to backup withhold on that second $500 payment.
If a contractor does work at someone’s house, do they have to issue a 1099-MISC?
That’s a good question because we’ve been basically talking about Forms 1099 in regard to businesses. And the answer to that is it’s only businesses only if the payment that’s made to the independent contractors is made in the course of a trade or business. So individuals who hire workers to perform work around their house as homeowners, whether someone’s putting a roof on their house or you hire a landscaper, those are independent contractors. But a homeowner, an individual, is not required to file a 1099, only if those payments are made in the course of a trade or business. The difference would be if your house was your business property maybe and you were running your business out of the house and you were hiring them to maybe install a business sign or something out in the front of your yard or something, then you would be required to issue a 1099.
If a person owns rental property and they receive payments for rental, does that need to be reported on a 1099-MISC?
Yes, rental payments, again, there are specific requirements regarding rental payments. But businesses that make rental payments are required to issue 1099s. There are some types of exclusions as to when they don’t have to issue them, and that information can be found in the publications on the 1099 reporting requirements.