Independent contractor rules assist the IRS in determining whether you have correctly classified your employees and contractors.
Employee payroll tax rates and benefits are more costly to the employer. It can be advantageous to hire an independent contractor (IC) instead of an employee ... that's why it is a frequently audited area.
Make sure you verify that your independent contractors actually meet the criteria ... and are not really employees.
Consider viewing the 2015 IRS webcast on Payments to Independent Contractors or download the transcript ... choose your preference. (I hope IRS update the format for this webcast as Adobe Flash was discontinued in 2021 and the webcast requires it to view.)
✔ Employee Payroll Taxes
✔ FICA & FUTA Rates
✔ Business Travel Allowances
✔ and more
✔ Payroll Tax Deposits
✔ Forms 940 & 941
✔ Correcting Form 941
✔ Notice 4520
✔ FUTA Credit Reductions
✔ Employment Forms
✔ W2, W3, W4
✔ Form 1-9
✔ New Hire Paperwork
✔ Independent Contractor Rules
✔ Forms W9, 1096, 945, 1099-MISC
Click here to find information on how the IRS is using the Form 1099-K and how it affects processing of your 1099NEC and 1099MISC.
At the American Payroll Association's (APA)
29th Annual Congress, Steve Hodgson, CPP explained that one way the IRS
audit independent contractors
is through the 1099 Matching Program.
IRS auditors look at individuals who have only filed one Form 1099-NEC (1099-MISC prior to 2021) indicating they may be an employee and not a contractor; or individuals who receive a 1099-NEC (Form 1099-MISC before 2021) from the same business in more than one year.
UHY Advisors recommend that you should receive and have on file a Form W-9 Request for Taxpayer Identification Number and Certification from each independent contractor; complete with address and TIN ... BEFORE they do any work for you.
Consider including in the written agreement an outline of their federal tax obligations.
AIPB's December 12, 2011 free eNewsletter advised that in addition to sending independent contractors a 1099-MISC, you should also have each independent contractor sign Form 4699 - Statement of Payments Received ... especially if you have few or no employees.
The IRS have an excellent 2 page pamphlet (publication 1779) that discusses the subject. It is concise, easy to read. It is titled Independent Contractor or Employee and can be found at www.irs.gov/pub/irs-pdf/p1779.pdf .
This pamphlet looks at the three categories the courts have considered when determining whether a person is an employee or an independent contractor:
The Montana Arts Council website (art.mt.gov) has a PDF you can download called IRS 20 Point Checklist for Independent Contractors that lays out the independent contractor rules. The 20 items checklist identified below all fit into one of the IRS's three categories of independent contractor rules shown above.
I've listed the independent contractor's checklist discussed in the article and added which IRS category I think they fall under:
Answer these questions to help determine if you are an independent contractor or an employee:
Prior to 2021, independent contractors received a 1099-MISC which recognized their compensation in box 7. As 2021, independent contractors (non employee compensation) receive a 1099-NEC. They will use the tax slip to calculate and pay their own taxes and may deduct expenses on Schedule-C when filing their income tax return.
New for 2020 tax year, you will now use Form 1099-NEC to report independent contractor payments instead of the Form 1099-MISC (box 7) as in prior years. Form 1099-NEC should be presented to service contractors by February 1, 2021. The contractor receives Copy B.
You may file the forms using a truncated taxpayer identification numbers (TTIN) ... the first five digits are replaced with an "x" or "*" ... to prevent identity theft.
The IRS receives Form 1096 Annual Summary and Transmittal of U.S. Information Returns AND Copy A by February 28 ... March 31 if filed electronically.
To send the 1099s by email requires the explicit permission of the contractor.
Form 945 Withheld FIT on Form 1099 is also due January 31, 2021.
As Robert Wood, tax lawyer and Forbes columnist likes to say, "It's better to give than receive." :)
Source: The Bookkeeper's Notes Newsletter
According to Jean Murray in What Factors Does the IRS Look at in Determining Independent Contractor Status?,
the IRS does not look at any one factor but at the "whole" picture the
answers to the questions create. Jean also mentions that IRS starts with
the presumption that the worker is an employee.
AIPB's free newsletter dated October 1, 2012 reviewed an IRS court case they won and the individuals were classified as employees rather than independent contractors. The court stated the facts and circumstances they used to make their decision were:
3 General Rules
One - Only payment for services delivered (not merchandise goods) to your business are reported. This means personal payments to you are excluded. It also means wages to employees are not reported here.
Two - Payments that total $600 or more for the reporting year AND were paid to an individual (meaning sole proprietors, independent contractors, or self-employed) are reportable on the Form 1099. Also, suppliers who are not filing a corporate tax return. LLCs can file either as a sole proprietor / partnership or an S-Corp. Check their W-9 to determine their status.
Three - Payments were made by cash or cheque are reportable on the Form 1099. Payments made through a third party provider (such as credit card, PayPal or Venmo payments) will be captured on a 1099-K. They are NOT reported on the 1099-NEC. You do NOT have to report amounts below the 1099-K threshold of at least 200 transactions and at least $20,000 in total payments.
See the compliance reminder above for current due dates.
Who should not receive a 1099-NEC?
Real estate agents are not considered individuals for these purposes so do not report rent paid to real estate agents.
Payments to corporations are not reported on the 1099-NEC. If the payment pertains to medical and health care payments, attorney's fees, or cash paid fish purchases ... yeah you read that right ... cash paid fish purchases ... it's one of those quirks! ... then it is reported on the 1099-MISC.
An article by Nina Kaufman, Esq. from Ask the Business Lawyer.com on How Independent Contractor Agreements Protect your Pocketbook explains one of the ways government raises revenue is by "more closely enforcing their laws, and levying penalties against those who violate them."
If you intentionally misclassify a worker as an independent contractor, the IRS can reclassify the worker as an employee.
When this happens, the employer (that would be YOU) would be responsible to pay ALL related payroll taxes and withholdings including the employee's portion ... plus late payment penalties and interest. If this happens to you, make sure you get legal advice on safe haven provisions as it pertains to your situation.
The IRS can also assess failing to pay employment taxes and failing to file required tax form penalties. State penalties also apply.
The employee payroll tax penalties are reduced if the worker was unintentionally misclassified. NACB Payroll Tax Update reports:
"The IRS penalty for unintentionally failing to withhold federal income tax is 1.5% of the wages paid. This assessment is doubled to 3% if the employer failed to file an information return (Form 1099-MISC) for the worker with the IRS. The IRS penalty for unintentionally not withholding the employee's share of Social Security and Medicare taxes is 20% of the employee's share of the tax. The penalty is doubled to 40% if the employer failed to file an information return for the worker with the IRS."
Nina explains that a written agreement can be a valuable weapon if/when one of these three scenarios puts YOU as a small business owner on the IRS's radar.
When completing the IRS Form 1099-NEC, always use the individual's legal name for a sole proprietorship or independent contractor.
However, if the business operates under a DBA (doing business as), use the DBA name on the Form 1099.
When preparing the Form 1099 for a business or partnership, use the entity's name.
Even if you paid the Independent Contractor by credit card, PayPal or Venmo, you may still need to send a 1099-MISC for any amount paid by cash/cheque if the criteria (see side bar above) is met. Does this mean that some payments will not be captured on either the 1099-NEC, 1099-MISC or 1099-K? Yes but not your problem. Why? You don't know if the IC will receive a 1099-K. You don't know if the IC had over $20,000 in sales and over 200 transactions.
Editor's note: Effective for 2023 payments, the threshold for 1099-K REPORTING will be a $600 threshold. 2022 will be a transitional year and will follow the "old" rules.
If you hire ICs, you want to be up on your independent contractor rules. A good place to start is the IRS webcast on 1099 MISC Filing requirements at:
While it is directed to governmental agencies and even with the new 2020 changes, you may find some useful information. As of 2020, nonemployee compensation is no longer reported in box 7 of the Form 1099-MISC. It now gets reported on Form 1099-NEC.
The transcript says it will cover "your responsibilities for filing Form 1099‑MISC and the corresponding Form W‑9. We will be discussing reporting of rents, nonemployee compensation, royalties, other income and gross proceeds to attorneys." Backup Withholding was also discussed including how to deposit it.
At the above link, you will find a transcript of the webcast (great if you prefer to read ... which I do ... much faster than watching a webcast), a copy of the slides used in the presentation and the handouts.
The handouts are good. They summarize the webinar with all the important points ... just as if you took notes at a lecture.
Source: IRS & AIPB & Tax Receipts.com
If you decide you need more information about the independent contractor rules, an additional reference to consult is the IRS Publication 15-A Employer's Supplemental Tax Guide.
If after reading the IRS information you still aren't sure how to classify your worker ... employee payroll tax help is available. Ask for an IRS ruling by filing Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Another good resource you might want to tap into for independent contractor rules is SBA.GOV (www.sba.gov)> establishing a business> hiring> independent contractors vs. employees.
They published a great article on November 7, 2011 titled, "How to Use Subcontractors to Save Money and Increase Business Agility" by Caron Beesley. You can locate it at SBA.GOV> Community Home> Community blogs> Small Business Cents. It discusses the pros and cons of working with subcontractors.
SBA.GOV (formerly Business.GOV) is the official business link to the U.S. Government.
If you are a Canadian company and hire a US citizen under independent contractor rules, you will need to send the IRS Form 1099-MISC.
To do this, you will need the US citizen's social security number.
Don't forget to give the US citizen a copy of the IRS Form 1099-MISC for their records to use for their income tax preparation.
You can find a copy of the IRS Form 1099-MISC at www.irs.gov/pub/irs-pdf/f1099msc.pdf ... BUT you can't file the online form as it is not scannable.
You order the form from IRS free of charge. If you are located in the U.S., contact the IRS toll free at 1-800-TAX-FORM.
However, if you are in Canada, alas the toll free number does not work. You will have to telephone or FAX the Philadelphia Service Center office for assistance at:
Tel: 215-516-2000 (not toll-free) or Fax: 215-516-2555
LET'S CHAT ABOUT ...
Robert Woods, tax lawyer, author and blogger wrote, in a checklist about the independent contractor (IC) rules, about what to include in a written agreement.
The written agreement should cover who has "the right to control the manner in which services are performed. Consider obligating the employer to pay for a finished product."
All you efficient bookkeepers out there, take note. Mr. Woods says the contract should NOT be a template. Use the checklist to customize each written agreement and state the facts of each agreement by clearly discussing the following independent contractor rules.
To read Mr. Woods entire article, which I recommend, Bing/Google "Ten Tips for Drafting Independent Contractor Agreements". You are looking for the Daily Tax Report Vol. 10, No. 125 July 1, 2010.
You may also want to read Robert Wood's article in Daily Tax Report Vol. 9, No. 195 from October 13, 2009 titled "Ten Things GAO Has to Say About Employee/Contractor Misclassification".
On September 5, 2011, the IRS introduced a new program that allows tax relief to eligible taxpayers for reclassifying independent contractors as employees. The program is called Voluntary Classification Settlement Program (VCSP).
The program was modified in 2012.
If you have consistently (for the past 3 years) followed the independent contractor rules by treating your workers as independent contractors AND filed all the associated Form 1099-MISC paperwork AND are not currently under audit BUT want to prospectively treat them as employees THEN file Form 8952 60 days before you begin the reclassification.
It does require you enter into an agreement with the IRS agreeing to pay 10% of the amount of employment taxes calculated with NO penalties and interest AND you will NOT be subject to an employment tax audit for the prior years.
Announcement 2011-64 at www.irs.gov/pub/irs-drop/a-11-64.pdf was superceded by Announcement 2012-45 at www.irs.gov/pub/irs-drop/a-12-45.pdf. Visit the IRS website for more information.
I'll close this chat on independent contractor rules by quoting Nina's article mentioned above.
your company uses independent contractors to staff its work force, be
very careful that you do this properly. You want to be sure to use
people who can properly be classified as independent contractors and are
not just part-time employees in disguise."
Use the search feature to quickly find the
information you're looking for.
Click on image above to read the chat.
Join Me On Facebook
Help support this site by "liking" me! Here's where I post current information.
Listed Under Websites NOT Local Business.
This website is NOT associated with the business operating in Bonnyville AB.