In order to have an efficient and stress-free 1099 reporting process, it is critical to have the necessary information for reporting. Although there are various types of 1099s, this discussion will focus on the 1099-MISC, which is applicable to independent contractors and third-party service providers; however, the strategies for collecting the requisite data for reporting are the same for all types of 1099s.
Step One: Evaluate Employees vs. Independent Contractors
The first step in reporting for 1099s is to determine for which vendors a 1099 must be issued. Form 1099-MISC is most commonly used for reporting payments to non-employee service providers. Before any payments are made, a determination of whether a payee is an employee or an independent contractor should be performed. Some questions to ask to aid in making this determination are related to control over an individual’s work being performed:
- Can the individual set his/her own hours?
- Can the individual negotiate his/her own rates and fees with you?
- Can the individual choose his/her own workspace?
- Can the individual work for multiple companies?
- Does the individual use his/her own tools and supplies?
Although control is not the only criterion in the determination if three or more of these questions are answered “yes”, it is likely the third party is an independent contractor.
Step Two: Determine which Service Providers Require 1099
Once the determination is made regarding employee vs. non-employee status, a decision can be made about which of these service providers should receive a 1099-MISC. The following is a general list of those who would require 1099 for the calendar year aggregate payments in excess of $600:
- Any individual, partnership or LLC (unless taxed as a corporation), in some cases expense reimbursements should be included.
- Payments to a medical or health care company, regardless of the type of entity.
- Payments to an attorney or law firm, regardless of the type of entity.
- Payments to a landlord for rent.
Payments to a corporation or LLC being taxed as a corporation are exempt from the reporting requirements with the exception of those noted above, Also, payments for merchandise, telegrams, telephone or freight, payments to tax-exempt organizations and payments to real estate agents are not required to be reported on Form 1099-MISC. Expenses should be included in the following instances: expenses for parts or materials used to perform the services if supplying the parts or materials was incidental to providing the service or travel reimbursement for which the nonemployee did not account to the payer.
Step Three: Ensure Form W-9 is Received for All Vendors
A Form W-9 should be obtained before paying any service provider during the course of the year who is not an employee. Unfortunately, however, many times these forms are not collected in advance. If the Form W-9 is collected during the year, the 1099 process at year-end is much more efficient and problem-free. A Form W-9, Request for Taxpayer Identification Number and Certification, is a one-page form the payee completes and provides to the company proving payment for services rendered. The completed form provides the legal name, address and type of entity of the vendor as well as the federal identification number for businesses or social security number for individuals. This information is required to file Form 1099-MISC.
Step Four: Preparing for Year-End
Once the receipt of all W-9s is completed and the determination is made about which parties should receive a 1099-MISC, the reporting can commence. Some best practices to further simplify the reporting process are:
- Review the vendor list and eliminate duplicates
- Deactivate old vendors no longer used.
- Run identification information provided through the IRS Taxpayer Identification number (“TIN”) matching program and follow up with any vendors whose data was rejected.
- Check for any changes to the reporting process issued by the IRS to ensure compliance.
Also, it is important to keep in mind the due dates to avoid late filing penalties, which can be substantial.
- January 31 – 1099s must be provided to third party payees
- January 31 – 1099-MISC must be sent to the IRS if it is reporting nonemployee compensation
- February 28 – all other types of 1099s must be sent to the IRS if sending by mail
- March 31 – If filing other type 1099s (non-1099 MISC) electronically, must send to IRS by this date (note: companies filing over 250 forms must e-file)
Penalties for not filing timely or filing incomplete returns can be up to $270 per Form 1099. The penalties are greater if the reported information is incorrect and a failure to correct the information is due to intentional disregard of the requirements to file. In addition to imposing penalties, if the incorrect 1099s are not corrected, the IRS can require backup withholding at 28% in the future.
Best Practices: Prepare Before Reporting Time
A review of company practices should reveal where weaknesses in the 1099 reporting process may exist. A summary of best practice tips include:
- Require all new vendors and contractors to complete Form W-9 at the beginning of the relationship and keep it on file.
- Implement a policy that a Form W-9 be on file before issuing any payment to a vendor or contractor.
- Review the active vendor list annually and require a new Form W-9 for each continuing relationship.
- Use the IRS TIN matching program for all vendors and contractors and follow up immediately if a discrepancy is found to eliminate issues at year-end.
- Review requirements in states where the business is conducted to ensure compliance in those jurisdictions.
Preparation and proper planning are the keys to seamless, efficient year-end 1099 reporting. Although the forms themselves are not complicated, the failure to have the required information beforehand can cause the process to be much more difficult and can increase the risk of penalties for non-compliance. When in doubt, it is always prudent to contact a tax professional to ensure compliance and to answer any technical questions that arise.
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