Here’s a comprehensive approach to understanding everything there is to know about Form 1099-NEC, non-employee compensations, and its reporting requirements.
A few years ago, when the gig economy was not taken seriously and employees were misclassified as independent contractors, businesses found loopholes within the IRS Form 1099-MISC reporting requirements. A regular miscellaneous information reporting form, which did not require much other than the payments made to independent contractors or non-employee workers.
The malpractice of misclassifying employees and non-employee workers was soon caught by the IRS. And so, Form 1099-NEC, non-employee compensations was introduced by the IRS to enforce businesses to classify and create the distinction between 1099 workers and W-2 employees.
This lead to a whole new regime of tax practices, which requires businesses to sternly stick to the rules. Today, we will discuss everything there is to know about Form 1099-NEC, its reporting requirements, and its inevitable impact on the gig economy.
But let’s start with some basics here.
What is Form 1099-NEC? Here’s the official answer directly from the IRS.
IRS definition of non-employee compensation: Form 1099-NEC
The IRS defines Form 1099-NEC as an information return that specifically reports all compensations made to non-employee workers, such as freelancers, independent contractors, vendors, attorneys, and more. All the compensations paid to these non-employee workers are termed as “non-employee compensations”.
The IRS requires businesses to report non-employee compensations on Form 1099-NEC to differentiate the payments made to non-employee workers and cross-verify the incomes received by self-employed individuals.
Classifying a worker: Non-employee and employee
The terminology used in the context, “non-employee worker” may seem confusing at times. Fundamentally, a non-employee is an individual who is not employed by the employer. However, in this context, a non-employee worker is hired by a business or an individual but not employed.
This means a non-employee worker is not subject to the same tax regime or employee benefits, differentiating them from an employed worker or an employee.
We have done the work for you to help tell the difference between a full-time employee and a non-employee worker.
|An employee is an individual recruited by the employer for a specific term or an indefinite period||A non-employee worker could be an individual or an entity hired for a specific project or work for a pre-defined term.|
|Businesses need to report employee compensations with IRS Form W-2||Businesses are required by the IRS to report non-employee compensations with Form 1099-NEC|
|The employee compensations include salaries, wages, health insurance, unemployment benefits, bonus, and other variables.||Non-employee compensations are just payments made to the independent contractor in exchange for services|
|Employees cannot delegate their tasks to other resources unless the employment contract makes an exception for it||Non-employee workers, such as freelancers, independent contractors, and vendors can delegate their tasks to internal and external resources as needed|
|Employers withhold federal taxes from employee compensations||Employers withhold federal taxes from independent contractors only when the vendor does not provide their taxpayer identification number or submits an incorrect TIN|
|Employed workers are the employees of the company or the entity or the employer||Independent contractors are self-employed and hired by entities or individuals|
Tax classifications for employees and non-employees
Let’s discuss tax classifications for employees and non-employees.
Tax classification for employees:
Employees are classified as employees from a tax perspective when the employer reports the compensations on Form W-2. Employers must report employee compensations with Form W-2 and its variants for employee tax compliance. There is no minimum payment threshold for employees and all compensations must be reported on Form W-2.
Tax classification for non-employees:
Independent contractors, freelancers, and vendors are classified as non-employee workers. There is no comprehensive tax regime in place here as there is for employees. However, employers that have paid $600 or more to independent contractors in a tax year in the course of business, are required to report these compensations on Form 1099-NEC.
Form SS-8 for the suspicion of misclassification
While compliant business arrangements are the ultimate goal, some businesses may look for the loose-ends of the tax regimes to reduce the tax burden. This is especially common with industries that want the resource advantages of a full-time employee but also want the no-strings-attached approach of the freelance economy.
There were instances in the past where well-known companies hired full-time employees but misclassified them as independent contractors to reduce organizational costs and tax burden.
In such cases, the misclassified individuals chose to report the issue to the authorities. The businesses were penalized heavily for misclassifying their employees.
If you’re a full-time employee but your employer sent you a 1099-NEC instead of a W-2 form or vice-versa, all you have to do is fill out Form SS-8 and submit it with the IRS. Once the IRS steps into the picture; the employers will be obligated to classify the individual per the tax laws. You can do this by filing Form SS-8 and reporting the misclassification or suspicion of misclassification.
Employer benefits of hiring non-employees
Employers often hire independent contractors for a variety of reasons. Some of these reasons being, ease of work, no-strings-attached approach, cost-effective business arrangement, and of course, reduced tax burden.
Here are a few reasons why businesses choose independent contractors.
Performance is not your problem
While hiring an employee means creating an ecosystem of dedicated resources who work with the employer on a variety of projects, the employer is constantly worried about performance and productivity factors. With independent contractors, you no longer have to worry about performance factors, such as productive hours, pay scale, etc.
Focus on business
With independent contractors, the employer can strictly focus on business operations and the deliverables, giving them the peace of mind and the bandwidth to expand into other verticals of the organization.
Ease of work
Employers do not have to worry about creating a physical space within their office for a resource. Most freelancers or independent contractors work remotely and have their own dedicated workspaces.
Further, the employer doesn’t have to constantly worry about the status of a project or a task. Most freelancers create a reliable atmosphere for their clients, allowing you to track the status of the project or a task at mutually-agreed timelines, giving you the needed insights.
Outsourcing the work means that you are only worried about the outcome and not the process of the outcome. This gives you the room to reduce some overhead costs, such as the employee salaries, insurance, and unemployment benefits, and costs saved on workstations, hardware, software, and other miscellaneous.
Eliminated tax burden
IRS requires hiring entities to report the compensations paid to the independent contractors. Just file a 1099-NEC and you’re good to go. Further, you don’t have to worry about withholding any federal taxes, such as Medicare from the independent contractor’s compensations.
Examples of non-employee compensation
The following example cases will help you understand what exactly non-employee compensation is and how to spot one if you’re considering a hirer-contractor business arrangement.
Case 1: Payment of $800 to a freelance designer
Imagine this. You’re starting a new project for your organization and need a digital designer to help you with some design work. So, you go online and look for freelance designers near you and hire one. Everything is sorted out and here are the details.
The freelance designer agreed to work with you for a period of 3 weeks for a total payment of $800
And once the work is delivered during or by the end of this period, you pay the designer $800 as agreed.
This can be defined as a simple, non-employee business arrangement.
Key points to be noted:
The payment is for $800 – which qualifies for federal reporting
The relationship was established for a business purpose – which means that you paid the designer in the course of your business
During the agreed 3-week period, you did not provide a workspace facility, pay any salaries, or provide any employee benefits to the designer. This makes it a complete non-employee business arrangement.
Case 2: Payment of $1200 to a copywriter as independent contractor
Imagine that you hired a copywriter for a period of 2 months. Your company just expanded its digital operations and is looking at putting in quality copywriting on your digital experiences, such as websites, social media, business brochures, and more.
You’re paying the independent contractor a monthly fee of $1200 for the period of three months.
After the end of each month, your accounting team is processing a payment of $1200 to this copywriter. At the end of the mutually-agreed period of 3 months, the work was completed as planned.
This can also be defined as a simple, non-employee business arrangement.
Key points to be noted:
The payment is for $1200 – which qualifies for federal reporting
The relationship was established for a business purpose – which means that you paid the copywriter in the course of your business for the pre-defined period of three months
During the agreed three-month period, you did not provide a workspace facility, pay any salaries, or provide any employee benefits to the copywriter.
This makes it a complete non-employee business arrangement.
Reporting requirements for non-employee compensations
If you’re a business, the following must apply for a payment to be qualified as non-employee compensation.
- You’re paying the amount to a non-employee worker or a self-employed individual
- The transacted amount has to be $600 or more
- The payment must be made in a business context (If you’re paying your friend $8000 to pull them out of a debt, it’s not a non-employee compensation. It’s a personal payment)
- The business and the contractor must verify each other’s TINs beforehand to ensure accuracy of the TINs reported
What is Form 1099-NEC and who needs to fill it out?
Form 1099-NEC is an IRS information return used to report non-employee compensations made to independent contractors by employers or businesses. The hiring entity or employer that paid the independent contractors must fill out the return to report all non-employee compensations made during a tax year to the IRS.
W-9 solicitation for 1099-NEC TIN matching and reporting
Businesses that are onboarding independent contractors must obtain the taxpayer identification number (TIN) prior to assigning work or making advance payments to ensure that the vendor is really who they say they are.
TIN matching or TIN lookup allows businesses to validate the identities of the vendor and verify the vendor’s profile for all future reporting and compliance purposes.
This verified information allows the businesses to report with Form 1099-NEC, which specifically deals with vendor compensations and the vendor tax information.
How to fill out and submit Form 1099-NEC?
Form 1099-NEC is relatively an easy form to fill. There are no complex fields; just boxes that require simple information. The following steps will help you fill out a Form 1099-NEC in a simple manner, eliminating all the complexities of reporting.
Step 1: Begin with payee information
Always start with the payee information because this is essentially the information that you need to report to the IRS. So, gather the required inputs from your payees, such as their TIN, name, business address, and annual transactional data. You can obtain the vendor TIN, name, and address with Form W-9.
Step 2: Enter the TIN after TIN Lookup
Once you have gathered the payee information, it is important to just validate the details prior to reporting them in the form. This logic holds especially true for TINs where each TIN discrepancy with the IRS could cost you at least $250 in penalties. TIN matching, especially real-time TIN matching as offered by Tax1099 will help you check as many as 100,000+ TINs in less than a minute, allowing you to save time on validating the information and accelerate reporting accuracy.
Step 3: Enter your entity’s TIN
After you’ve reported the payee’s information, it is time to start reporting your entity’s information. Start with validating your own TIN just to be on the safe side and report it in the payer box. Enter the business address per the official records.
Step 4: Figure & Report Federal Withholdings
When the payee (in this case, an independent contractor) does not provide their TIN, you can withhold a percentage of the payments from the contractor and report these withholdings in Box 4 of Form 1099-NEC. This box exclusively reports federal tax withholdings from the payments due to the payee.
Step 5: Non-employee compensations paid
Report the total compensations or the total amount you have paid to your freelancer or vendor or independent contractor in a year on Box 1 of Form 1099-NEC. For example, if you have paid $400 to a freelance designer every month for 6 months, then you must report $2400 ($400 x 6) as the total nonemployee compensations paid. The federal withholdings and the nonemployee compensations must correlate.
Note: It is essential to understand that you cannot file a single 1099-NEC form for all your independent contractors. You have to file Form 1099-NEC for each independent contractor to whom you have paid at least $600 or more in a tax year in the course of your business.
Step 6: State income tax withholdings
Certain states require businesses to withhold taxes from payments to contractors to ensure tax compliance. In such a case, your business must report the amount withheld from the payments due to the payee on Box 5 of Form 1099-NEC.
1099-NEC: Paper filing
There are two methods by which businesses can file their 1099-NEC forms. One method is a traditional method of filing, which has been in use for several decades. Paper filing is one of the oldest and traditional ways of filing IRS returns. In 2020, when the Covid-19 outbreak was its worst, the IRS recommended and encouraged taxpayers to choose the eFiling method to file the returns.
Taxpayers can download the returns from the official portal of the IRS at www.irs.gov and download the scannable returns. Do not print out the forms from just any site because the IRS will reject your returns if the forms are not scannable.
To make things easier, the IRS also takes bulk form requests from entities so you file original and valid returns to the IRS through the mail. You can request original IRS forms from the IRS here.
eFiling is nothing but filing your 1099-NEC returns electronically through a secure medium. Digital tax compliance enablers like Tax1099 allow taxpayers to easily report and file their IRS returns in a simple and secure manner.
Given the current safety measures you need to follow in order to paper file your returns, e-filing is an easier and safer alternative, giving you additional time to focus on your reports.
With TIN matching, address validation, and other digital report validation tools offered by Tax1099, you can easily eFile 1099-NEC online in just a few minutes.
But before we get to know about the eFile process for 1099-NEC online with Tax1099, let’s learn a few more things about the form.
For example, when is the form due, and is this newly-introduced form a part of the CF/SF program?
Let’s get to it.
When is Form 1099-NEC due?
After Form 1099-MISC was redesigned and Form 1099-NEC was introduced, the IRS removed the automatic 30-day extension for the forms and accelerated the deadline to January 31 of every tax year.
So, the IRS requires businesses to file Form 1099-NEC on or before January 31 of every tax year and send a copy of the 1099-NEC form to the payees on or before February 1 of every tax year.
And there’s more.
IRS Added Form 1099 NEC to the CF/SF Program
The IRS has added Form 1099-NEC to the combined federal and state filing (CF/SF) program. This means that businesses can directly submit the returns through the state filing programs. Further, businesses need to look out for state-specific reporting requirements for Form 1099-NEC to ensure tax compliance.
Made a mistake on Form 1099-NEC? Here’s how to correct it
If you have reported something wrong on Form 1099-NEC; be it a TIN, federal withholdings, name of the payee, or even the state code, you can easily correct it by filing a fresh Form 1099-NEC. All you have to do is report the correct information and most importantly, select the ‘Corrected’ box at the top of the form to convey that this form is the corrected form, which will nullify the previously submitted form.
Manage & eFile Form 1099-NEC on time with Tax1099
Tax1099 is an IRS-authorized digital tax compliance enabler. Taxpaying business entities can easily report and eFile their 1099-NEC forms and submit the forms to the IRS within minutes. With bulk eFiling solutions, data import, sleek integrations, and smooth features, businesses can scale their tax information reporting as they grow and adapt.
With in-built dynamic tax calculations, the total tax you owe is calculated as you enter the information in the electronic returns.
API solutions enable businesses to eliminate workload and leverage automated tax reporting solutions.
Collectively, Tax1099 offers everything a business needs in order to stay compliant and helps maintain regulatory tax filing practices in check.
Our penalty prevention programs are one of the many reasons why businesses choose our tax compliance solutions. With Tax1099, you can schedule your eFiles so you never miss a deadline and prevent being penalized by the IRS for missed due dates.
You too can join the compliance journey loved and recommended by 100,000+ businesses like you.
So, whether you’re looking for simple e-file solutions or a comprehensive suite of tax information reporting, you will find it all with Tax1099. Subscribe to Tax1099’s exclusive blog for regular updates and keep yourself posted on the latest news as it unfolds.
eFile Form 1099-NEC online with Tax1099 now.