January is a “perfect storm” of tax deadlines for bookkeepers and business owners. Sales tax, payroll, property tax, estimated payments, and the dreaded (but necessary) 1099 filings all come due at the same time. Whether you are sending 1099’s or receiving them from other businesses, the whole 1099 reporting process can be a bit daunting. There are plenty of misconceptions about what should or shouldn’t be reported. Before we formally enter the filing season, allow me to break down the rules for Nonemployee Compensation you in plain lingo.
Be aware that there will be a slight twist this year to the familiar 1099-MISC filing process. In the past, Form 1099-MISC was broken down into 14 different categories of income, including the familiar Box 7 for Nonemployee Compensation. Starting with the 2020 tax year, payments made to contractors and freelancers will be reported via the new and improved 1099-NEC. Since that is the prime reason that many small businesses need to file a 1099, we will focus the most of this article on Form 1099-NEC.
What is the purpose of 1099-NEC reporting?
A recent accounting survey revealed that around one fifth of small businesses in the US don’t use bookkeeping software or online apps to manage their accounting. Some of these companies may keeping their books on paper ledgers, but in reality many small businesses don’t have a proper accounting system in place. The proverbial “shoe box” isn’t a myth.
The IRS is aware of this, and is justifiably concerned that without some basic governmental oversight, small businesses will understate their taxable income. By requiring businesses to report payments made to other businesses, the IRS can more easily identify potential under-reporters. The 1099-NEC form is essentially an information return that helps the IRS monitor small businesses revenue reporting.
For the past few years, the other boxes of the 1099-MISC had a later due date than Box 7, which has led to some confusion. To resolve this issue, the IRS has decided to move Nonemployee Compensation to it’s own form. To avoid penalties, the 1099-NEC needs to be postmarked or electronically distributed to all required parties by January 31st.
Who should receive a 1099 and why?
What kind of businesses should receive 1099’s? Individuals, partnerships, estates, and in some cases, even corporations. For instance, gross proceeds to an attorneys is reported on Box 10 of the 1099-MISC, whether corporate or not.
A reporting category that is often overlooked by small business owners is Box 1 of the 1099-MISC. If your business rents an office (or equipment) unless your landlord is a real estate agent, a tax-exempt trust, or an S or C Corp, you should be sending them a 1099. Were you aware of this requirement?
The old Box 7 was specifically for reporting “services performed by someone who is not your employee (including parts and materials)”. That would include payments made to independent contractors, attorneys, accountants, janitors, computer technicians, etc. The key word in this category is “services”. These payments will now be reported on Box 1 of Form 1099-NEC instead.
What are the dollar limits for 1099 filings? For most categories, a cumulative amount of $600 or more in cash and/or check during the calendar year. If you exchange services or goods in lieu of payment, that is also be considered reportable compensation.
How do I know whether a business is exempt from 1099 filing?
Always request that the business fill out and sign a Form W-9 before you send them payment. This form will help you determine whether you will need to send them a 1099, as it will indicate whether they are S or C Corp or otherwise exempt. It will also provide the information you will need when it comes time to file (name, business name, address, tax ID). By signing the form, they are making themselves legally responsible for the information they have provided you.
If the business has the word “Incorporated” in their name, it’s a pretty safe assumption that they will be exempt from filing. But be careful with the LLC’s and partnerships. Many people think that LLC’s are automatically exempt, but that’s only true if they have elected S or C Corp status. You won’t know until you see their W-9.
Did you know that payments made to 1099 eligible vendors are subject to a mandatory 24% Federal backup withholding if you don’t have a valid W-9 on file for them? If you fail to follow protocol and the IRS is unable to collect, you could end up liable for a portion of the taxes due.
Why aren’t credit and debit card payments included on the 1099-NEC?
A few years ago the IRS realized that the merchant service companies have huge databases of payment information regarding small businesses that could be easily tapped. Businesses that accept credit card payments now receive an annual 1099-K report from each merchant service provider stating their gross credit card sales, broken down by month. Since this total could potentially include sales tax collected and employee tips, and doesn’t include cash sales, it’s not a hard sales number, but it provides a general picture that helps the IRS “red flag” businesses for potential audits.
Since credit card payments are now reported on the 1099-K, businesses should no longer report payments made by credit card (including PayPal) on 1099-NEC filings. Keep in mind that paying via ACH or online banking doesn’t meet that criteria since it’s not processed by a payment settlement entity.
Do I need to keep track of my income if I’m going to receive a 1099-NEC at year end?
The 1099’s you receive each year from other businesses may not be your reportable business income total. All businesses are required to independently track and report their own income, instead of relying on other businesses to report their income for them. Why would you want to base your tax return on someone’s else’s books?
Here are several reasons why your total income may differ from the 1099’s you receive:
- When cash and check payments made are under the $600 limit, no 1099 is filed.
- Personal services aren’t usually reported on 1099’s since 1099’s are generated by businesses, not individuals.
- The business providing the 1099 may have miscalculated the amount on your 1099.
- There could be timing differences between your business and the business sending you the 1099. A payment made at year end may not be physically received until the new calendar year.
As long as your total business income is more than the total on 1099’s you have received for the year, timing issues won’t raise red flags with the IRS. If your total income reported is less than the 1099 amounts, you may want to provide an explanation on your tax return in order to avoid receiving a letter audit from the IRS.
Are there any risks in failing to file 1099’s for my business?
Have you noticed two important questions on your Federal tax return? In the heading of IRS Form 1040 Schedule C it asks: Did you make any payments in 2018 that would require you to file Form(s) 1099? . . . If “Yes,” did you or will you file required Forms 1099?
Do you understand the purpose of these two questions? They serve as a reminder of your obligations as a small business owner. Answer incorrectly and you’ve committed perjury. If you are audited by the IRS, and knowingly failed to file part or all of your 1099’s, you could also be charged with aiding and abetting tax evasion. Penalties may be the least of your worries.
Bottom line, be an honest and conscientious tax payer, and expect the same from those that do business with you. Take the time to dot all the i’s and cross all the t’s. It may be a little tedious, and you may end up a little poorer, but at least you’ll sleep well.
Here are few final 1099 tips:
- Don’t wait until the last minute to figure out the rules and collect the necessary information. Now is the time to start planning for next year.
- Create a vendor onboarding process and stick to it. Ask for the signed W-9 before you make payment to the vendor or contractor. Keep control of the process.
- Discuss the W-9 process with your staff and make sure everyone follows through. There’s nothing worse than chasing down missing W-9’s right before the year-end deadline.
- Be careful how you handle W-9’s, especially if they contain Social Security numbers instead of Employer Identification Numbers. Email isn’t a secure way to handle sensitive data.
- Upload signed copies of W-9’s to a secure portal so they are easy to find later. We use the Files section in our Xero cloud accounting file.
- Don’t forget to mark eligible vendors as 1099 recipients in your accounting software so they show up on year-end reports.
- Legitimately reduce the number of 1099’s you are required to file each year by choosing to pay via credit or debit card or PayPal instead of check or cash.
- Clearly distinguish between debit card payments and other types of bank payments when you are recording transactions in your bank register. You’ll need to be able to differentiate them at year-end.
- Since 1099’s are eventually matched up to personal and business tax returns, it is important that names and tax identification numbers are correctly reported. Inaccuracies may cause a mismatch, which could result in notices and potential penalties from the IRS in the future.
- If a 1099 is returned to you as undeliverable or you are notified of a mismatch, request an updated W-9 before making further payments to the the vendor.
- January 31st is the hard deadline for 1099-NEC filings. Only extensions for extreme circumstances are allowed. If you discover an error while you are closing your books, there is still a window of opportunity to correct it. Amendments can be made without penalty until August 1st, but if you file late (or fail to file and get caught) penalties will be assessed.
These are only basic guidelines – additional information and guidelines can be found at on the IRS website at https://www.irs.gov/forms-pubs/about-form-1099-misc and https://www.irs.gov/forms-pubs/about-form-1099-nec.
Feel free to contact us here at Level and True Accounting Services LLC for assistance with 1099-MISC and 1099-NEC filing and questions, or any of your other accounting and bookkeeping needs and concerns. We’d be happy to help you out.
Note that this article was originally posted in 2019, but has been updated to reflect current rules.
– Written by Gina Palacio, Owner of Level & True Accounting Services LLC