One of the changes businesses will see during the upcoming tax season is a redesign of the 1099 series of information reporting forms. This year, taxpayers must use a new Form 1099-NEC (Nonemployee Compensation) to report payments to nonemployees such as independent contractors, freelancers, and other service providers, rather than reporting them on Form 1099-MISC as they did in years past.
While the new Form 1099-NEC is relatively simple to complete, the redesign also triggered several rule and deadline changes that affect other information reporting forms.
The Basics – Which Forms to Use and When to File Them
Both forms 1099-NEC and 1099-MISC are used to report payments for services provided to a business, so the first step for most companies is to determine which of the two forms to issue to each provider.
Businesses should use Form 1099-NEC whenever they make payments of at least $600 for services performed by an individual who is not an employee. This includes payments to contractors and other vendors and the parts and materials that were incidental to the service they provided.
It also includes directors’ fees, payments for professional services, commissions to nonemployee sales agents, and taxable fringe benefits for nonemployees. Companies should also file a Form 1099-NEC for individuals from whom they withheld federal income tax under backup withholding rules, regardless of amount.
Businesses should continue to report other payments, such as rents, royalties, contest winnings and prizes, and payments for healthcare services, on Form 1099-MISC. In the case of payments to an attorney, the company should use Form 1099-NEC to report payments for actual legal services the attorney performs for the business but report other payments (such as payments made in a settlement agreement) on Form 1099-MISC.
Neither of these forms are used to report payments for merchandise, goods, materials, storage, or freight, or for the purchase of non-business personal services. Most payments made to corporations, including LLCs and S corporations, do not need to be reported on a Form 1099, but this exception does not apply to payments to attorneys, healthcare providers, and certain other specialized services.
The revisions to the 1099 information forms also caused some changes to filing deadlines. The due date for submitting Form 1099-NEC is February 1 for both the recipient and the IRS. The new 1099-MISC is also due to recipients by February 1, but the due date to the IRS is pushed back to March 1 for paper filers and March 31 if filing electronically.
There are numerous other exceptions and specific provisions for certain types of businesses and payments, so it is important to check with your Abbott, Stringham & Lynch tax professional before filing. In addition, companies should ensure they have updated accounting software that accommodates the revisions and have the right paper forms on hand. It is good practice to provide new vendors and service providers with Form W-9 (to obtain their taxpayer ID) before making any payments. This avoids the need to obtain taxpayer IDs when preparing 1099 forms.
The Critical Question—Employee or Nonemployee?
Properly filing the information reporting forms is actually the last step of the larger worker classification process—a process that can be complicated. The rules are complex and the penalties for improperly classifying workers can be substantial. In addition, worker classification also affects labor law compliance, and state labor codes may use different classification criteria than the IRS uses.
For many years, the IRS used a list of questions known as the “20 Factor” test to determine worker classification. Several years ago, it consolidated these factors into three categories:
- Behavioral control – Does the company have the right to control both what the worker does and how the worker does the job? If so, the worker is probably an employee.
- Financial control – Does the company control the business aspects of the relationship? Deciding factors include how and whether expenses are reimbursed, who provides tools, supplies, and training, and whether the worker also offers services to other businesses.
- Type of relationship – Written contracts help determine this issue. Other relevant factors include employee-type benefits such as insurance, paid vacations, and sick pay, all of which indicate the worker is an employee, not a contractor.
Several IRS publications can help companies determine how to classify workers. Publication 1779, “Independent Contractor or Employee,” provides a quick overview of the issues, while Publication 15-A, the “Employer’s Supplemental Tax Guide,” offers more detailed guidance including examples.
In 2019, California enacted Assembly Bill 5 (AB 5) which for many occupations abandoned the 20-factor test used by the IRS in favor of a three-factor test used by several other states. In 2020, legislation was passed modifying the rules of AB 5 and during the recent election Proposition 22 was passed modifying the rules for “gig workers”. Since California worker classification law is currently evolving and may not be consistent with federal guidance it is recommended that employers consult with a labor attorney for the latest information.
Please contact us if you have questions about service provider payments and reporting, and we’d be happy to help.