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 misclassified and everything else you need to know about the 1099 filing for independent contractors.
An IRS form 1099-Misc is issued whenever companies pay a person or a business more than $600 in total during the previous year. A 1099-Misc form is provided for several reasons but the one this post focuses on is the one issued to report payments for services performed by someone who is not an employee of the organization. The 1099 should only be issued to workers who qualify as independent contractors (something this blog has written about extensively in earlier posts).
There are some exceptions to the rules regarding who should receive a 1099. The loopholes in the IRS include wages paid to certain employees that would otherwise normally be reportable as W2 wages. There are some instances when 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 and or accrued vacation or other compensation needs to 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 an IC, they still get the posthumous 1099.
Another example regards payments made to an LLC that is a C or S corporation. If you’re paying a company as an independent contractor, (which is then cited in box 7 – specifically intended to log nonemployee compensation) the 1099 is used to include fees, commissions and payments for any services rendered by non-employees. When recording Payments to non-employees on the 1099 form, Box 7 is where payments of this nature must be listed.
Professional services fees from independent contractors are also reported via 1099. Examples of this reporting might 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 of 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 main indicators to observe.
Employees (who receive W2’s) have set work locations, hours and get direction from their employers and receive performance reviews. Whereas, independent contractors establish their own work hours, work at either their own locations or at various employer locations. They establish the sequence of the work they perform, establish their own workflows/timeframes and are not subject to performance review by the employer. (Their work quality and output may be evaluated for future projects but not formally reviewed.)
Core vs. Non-Core Assessment
Employees critical to the core operations of the organization are usually precluded from being classified as ICs. A good example of a core employee would be the chef of a restaurant. The chef is critical to the operations of a restaurant. Ergo, the restaurant cannot classify him as an IC for tax purposes. Independent contractors’ efforts must occur outside of their client’s operational goals and must not 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 must not receive training from the employing organization. An employee is often trained on processes or procedures of their employer. 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 that the various agencies (IRS, DOL and state Departments of Labor) use to review employee status for their evaluation purposes.
There are risks associated with utilizing ICs and issuing 1099s. The IRS maintains software programs to monitor businesses issuing 1099 forms to the same individuals year after year. The IRS shares this information with the Departments of Labor and they maintain partnerships with 36 states to work together on misclassification identification.
Prior to issuing a 1099 this year, evaluate the workers who were engaged in 2016. Ensure they meet the criteria of an independent contractor by reviewing the check list above. You can also engage nextSource or another 3rd 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 additional layer of protection and indemnification to your organization.