How are you managing your 1099s these days?
Every business owner knows the importance of strong financials. Without a solid balance sheet, it’s difficult to receive loans or attract investors. Yet, many companies fail to realize how accurate tax reporting contributes to a financially sound organization. For example, failure to file non-employee compensation on form 1099 can result in penalties ranging from $50 to $270 per form up to a maximum of $556,500 per year.
Suppose the IRS finds that a company intentionally failed to meet the 1099 requirement. In that case, they can assess a minimum penalty of $550 per form or 10% of the unreported compensation with no maximum limit. Penalties for failure to comply can damage the financial stability of any organization. That’s why businesses need to ensure that 1099 processing is accurate and timely.
Companies that wait until the last minute to complete a 1099 may find they lack crucial information such as a social security number or valid mailing address. Tracking down that data can be time-consuming, especially with a deadline approaching. If the services were received early in the tax year, the contractor may no longer be at the original address or have the same phone number, which compounds the problem. It’s even possible to overlook a contractor when pulling the information together before the cutoff date.
Whether you are an early filer or a procrastinator, having the right information in hand ensures 1099 filings happen on time with accurate information. Improperly managing your 1099s data can result in financial penalties and increased administrative costs.
What are1099-NEC and 1099-MISC?
Before 2020, companies used 1099-MISC to file non-employee compensation. In 2020, the 1099-MISC form was restricted to reporting rents, prizes, and awards income, and a new 1099-NEC form was created for non-employee compensation. When looking for 1099 forms, be sure to check the letters following the 1099 number. For example, 1099-INT is used to report interest income, while a 1099-R reports retirement distributions. Since the IRS has published 20 different 1099s, be sure you are managing your 1099s using the correct forms.
Employers no longer use the MISC form to report non-employee compensation. However, they may be required to complete a 1099-MISC if a non-employee is subject to backup withholding. The IRS lists multiple reasons for enforcing the backup withholding rule, but the primary impetus is failure to report an income source. If an independent contractor is subject to backup withholding, the company must withhold 24% of income and report it to the contractor on a 1099-MISC form before the 1099 filing date. A copy of the form is sent to the IRS.
Companies must issue a 1099-NEC to each independent contractor who receives more than $600 in compensation in a year. The form serves the same function as the MISC form prior to 2020. Companies are not required to issue 1099-NEC if the contractor receives less than $600 in compensation.
Proper classification of workers as employees or independent contractors is the first step in determining if a 1099-NEC is required. Although the Labor Department defines independent contractors, the IRS uses its own set of rules to determine a worker’s status. To avoid penalties, companies should apply the IRS criteria, which are based on the control a company has over the worker.
Businesses can use the following to determine the status of an individual.
- Contractual. Is there a written contract? Are benefits such as paid vacation or sick leave included?
- Financial. Do you determine what tools and supplies are provided? Can you decide what expenses are reimbursed?
- Behavior. Do you have control over what and how a worker performs their tasks?
Before deciding on a worker’s status, businesses should check with a professional to ensure they have not misclassified an employee.
What are the Penalties for Misfiling?
As indicated in the introduction, failure to file 1099s can result in fines up to $270 per unfilled form. If the IRS determines intent on behalf of the company, the penalties increase to $500 per form without a maximum amount. Although significant, these penalties are minor compared to the consequences of misclassifying an employee.
The IRS may assess penalties that include a $50 fine for each misfiled form, a 3% penalty on all wages, and a 40% penalty for all FICA taxes that were not withheld. In addition, the employer may pay up to 100% of the matching FICA taxes. These penalties are minor compared to those levied if the intent is proven.
The IRS may impose added fines and penalties if it suspects fraud or intentional misclassification. The fines may increase to 20% of all wages, plus 100% of FICA taxes for both employee and employer percentages. Criminal charges can be brought that include possible prison time as well as increased per misclassification fines.
What Information is Needed for 1099-NEC?
A 1099-NEC requires the following information:
- Non-employee compensation
- Company’s taxpayer identification number
- Contractor’s tax identification number, name, and address
- Any withholdings, if applicable.
If companies wait until the last minute to collect 1099 information, they may find themselves trying to track down contractors to collect the information or be forced to file without the necessary information. For companies such as construction, the number of independent contractors can be significant, and many contractors are transient, moving from one job site to another.
Collecting the necessary information at the start of the contract period or requiring that the information be supplied before the contract is generated are two ways to ensure the information is available when tax time arrives.
Submitting a 1099-NEC
Form 1099-NEC must be provided to the IRS and the contractor on or before February 1, according to the following:
- Copy A to the IRS with Form 1096
- Copy 1 to your company’s state treasury department
- Copy B to the contractor
- Copy C for your records
The IRS and state treasury departments use the information to ensure that all income is properly taxed. If the income reported on the 1099-NEC does not match a contractor’s reported income, the IRS may assess fines or penalties to the contractor.
The contractor can appeal the ruling indicating that your company made an error. This process requires you to support your reported figures, which only adds to the company’s administrative burden. To avoid these challenges, consider an accounting firm that understands how to manage 1099s.