Independent Contractor Compliance and the 1099 Form
With tax season upon us, let’s take a moment to review a checklist of what’s classified and what’s not, plus everything else you need to know about independent contractor compliance for 1099 filings.
Overview of Independent Contractor Compliance
An IRS form 1099-Misc is issued whenever companies pay a person or a business more than $600 in total during the previous year. Companies may give a 1099-Misc form for several reasons, but for this blog, we’re focusing on those issued to report payments for services performed by someone who is not an organization employee.
Essentially, the 1099 needs to be completed only by workers who qualify as independent contractors (ICs). However, there are some exceptions. These independent contractor compliance-friendly “loopholes” in the IRS include wages paid to certain employees that would otherwise normally be reportable as W2 wages. Sometimes, a worker qualifies as a W2 wage-earning employee but could still receive a 1099 form.
For example, when an employee passes away while in your employ and wages or accrued vacation or other compensation must be paid after their death, a 1099 form is needed so that social security and Medicare taxes are not applied. So, although this person did not meet the legal definition of independent contractor compliance in life, they still got the posthumous 1099.
Another example concerns payments made to an LLC that is a C or S corporation. If you’re paying a company as an independent contractor (cited in box 7 – intended explicitly for logging nonemployee compensation), the 1099 can include fees, commissions, and payments for non-employee services. When recording non-employee payments on the 1099 form, listing them in Box 7 is required.
Independent contractors can also report professional services fees via 1099. Examples of this reporting could include a blogger your company has engaged, a photographer used for producing a marketing campaign, or a high-level IT contractor used to complete a project for your organization. This reporting can also include reporting any travel reimbursements made to the contractor.
What Is “Classified” and What Is “Misclassified” – A Checklist
As we already know, it is critically important to clearly define when a worker qualifies as an employee and when they do not. Remember that this determination can vary by state and agency (the IRS versus the Department of Labor). However, in general, these are the leading indicators to observe:
W2 employees have set work locations, hours, structure that their employers direct and performance reviews. On the other hand, independent contractors establish their own work hours, working at their personal choice in private or public locations (like a home office or local coffee shop) or between various employer locations.
ICs establish the sequence of the work they perform, develop their workflows/timeframes, and are not subject to performance review by the employer. An IC’s work quality and output may undergo evaluation for future projects, but routine, formal assessment and inspection are unusual.
Core vs. Non-Core Assessment
Employees critical to an organization’s core operations are usually not classified as ICs, even if they have a reason to complete a 1099. An excellent example of a core employee is restaurant chefs, who are critical to the business’s operations. Ergo, the restaurant cannot classify them as an IC for tax purposes.
Independent contractors’ efforts must occur outside their client’s operational goals and cannot be integral to the businesses’ success or failure. Compared to the chef at a restaurant, an IT consultant at a business services organization suggests a non-core role as the operation will not cease to function in his absence.
If engaged as an IC, an independent contractor must be able to show proof of other clients, a tax ID number, and that they hold an occupation customarily engaged as an IC.
Independent contractors do not conduct training through the employing organization, unlike W2 employees whose preparation for their role or position relies on processes or procedures of employers. An IC must bring independent expertise to the project. In short, W2 employees are trained by the employer, whereas ICs are engaged to bring expertise to bear on a project basis.
These are just a few of the main factors the various agencies (IRS, DOL, and state Departments of Labor) use to review employee status for evaluation purposes.
Additionally, there are some risks associated with utilizing ICs and issuing 1099s. The IRS maintains software programs to monitor businesses distributing 1099 forms to the same individuals year after year. The IRS shares this information with the Department of Labor and maintains partnerships with 36 states to work together on misclassification identification.
Before issuing a 1099 this year, evaluate the workers engaged in 2016. Ensure they meet the criteria of an independent contractor by reviewing the checklist above. You can also hire nextSource or another third party provider to review all the associated risks and consider outsourcing the responsibility for IC classification and tax reporting to an expert group of professionals, adding an extra layer of protection and indemnification to your organization.