The Internal Revenue Service (IRS) requires business owners that hire independent contractors document the wages these workers earned through specific reporting requirements. Understanding the difference between an employee and a contractor, and identifying how an independent contractor hired by your company needs to have proper documentation for the IRS can help ensure that your company follows all the legal guidelines regarding taxation of earnings given these workers.
Employees vs. Independent Contractors
An employee and an independent contractor are different types of workers and receive different types of classification from the IRS. In most cases, an independent contractor is self-employed or owns their own company who then contracts with another company to perform a specific function, or job. Oftentimes, independent contractors may refer to themselves as freelances or sole proprietors, however, however they call themselves, they are not a direct employee of the company that they work for. This means that their hours and schedule are not as defined as an employee. An independent contractor has independent autonomy regarding how they do their work for a business owner. However, in both cases, a company is required to handle the tax withholding for both types of workers, as well as pay their Medicare taxes and Social Security taxes. While companies will pay the federal and state income taxes of their employees, the independent contractors will handle paying those taxes on their own.
Understanding the W-9 Form
A W-9 form is a tax form required by the IRS that is entitled “Request for Taxpayer Information and Certification.” This W-9 form is extremely basic and asks for fundamental information such as an independent contractor’s identifying tax information, either a social security number or an Employer Identification Number (EIN). It is important to note that if an independent contractor has an EIN, they are not required to put their social security number on the W-9 form. The W-9 form requires the worker to attest with a signed declaration that all the information is true and that they have the legal authority to work in the United States. If any worker does more than $600 of work within a year for a company, they need to legally fill out this form for the company. If an independent contractor fails or refuses to fill out a W-9 form, the company must then withhold 28% of their earnings for taxes.
Why W-9 Forms Are Important
W-9 Forms are important as they allow the IRS to identify and obtain information regarding independent contractors that may attempt to avoid claiming their income for tax purposes. Additionally, a W-9 form may help prevent a company from claiming illegitimate expenses that are fraudulent. No expenses for independent contractor work can be claimed by a company for taxes at year-end unless they have a corresponding W-9 form to accompany that independent contractor and must then issue a 1099-MISC Form. Finally, obtaining a W-9 Form ensures that companies do not hire undocumented workers that do not have the legal right to work in the United States. Hiring an undocumented worker is against federal law, and therefore ensuring that a company obtains a W-9 for all their workers is a key step to preventing this violation of federal law.
Where to Find a W-9 Form
You can download a free W-9 form from the IRS website in either English or Spanish. Simply go to the IRS website at www.IRS.gov and search for “W9”. You can download a blank copy of the W9 form along with very specific instructions that walk you step by step regarding how to accurately complete this important tax document.
Understanding the 1099-MISC Form
A W-9 form is a tax form that the independent contractor provides to the company that hired them to do a project or job. The 1099-MISC Form (also known as the 1099 Form) is a tax document that the IRS provides to the independent contractor as proof of earnings during that year. The importance of this form cannot be overstated, it provides the independent contractor proof of their payments for the year so that they can then process their financial statements for their taxes to the IRS correctly. This form needs to be provided every single year that an independent contractor works for a company and must be provided as soon as possible following December 31 of that year. The independent contractor has the legal right to receive their 1099 Form by January 31 of the following year, which is significant because they have the same tax deadline as all other businesses.
What Entities Receive a 1099-MISC Form?
If you are a business and want to ensure that the proper independent contractors receive a 1099 Form, the following is a list of all entities to whom a Form 1099 should be provided:
- Any independent contractor, a person who received a prize or award, income payment, rent, or service over $600 for the calendar year.
- Any payment to an attorney or medical corporation, even if the amount is below $600.
- Direct sales of a minimum of $5,000 of products for resale anywhere other than a physical or permanent retail business or establishment.
- Any royalties or broker payments in lieu of dividends or tax-exempt interest of at least $10.
- Any person that the company withheld federal income tax under the backup withholding rules. (In some cases, a company will need to withhold taxes for independent contractors under these federal laws.)
- Any rent paid to a landlord.
- Reporting of any crop insurance proceeds must be identified through a 1099 Form, which includes money that insurance companies will pay farmers for any crops that were damaged or destroyed, and therefore unusable or unsalvageable to sell.
- Recording of any fishing boat proceeds for any crew members that are self-employed that earn any kind of money on a fishing vessel or fishing boat.
- Any golden parachute payments, which would include payments such as cash bonuses, stock options or severance pay packages to any terminated employees.
Businesses do not need to issue a 1099 Form to any corporation with whom they did business (unless it is an attorney or medical corporation as indicated above), any employee that was issued a W-2 for their wages, or any payment to a tax-exempt organization including local, state and federal government entities and not-for-profit entities.
Other Types of 1099 Forms
There are other types of 1099 Forms that are specific for certain types of wages, including the following:
1099 DIV — Reporting of any dividend income or monetary distributions
1099-C — Reporting of $600 or more in cancellation of debt
1099-K — Reporting of any merchant cards or third party network payments
1099-INT — Reporting of amounts greater than $10 in interest income
1099-S — Reporting of proceeds from certain real estate transactions
Common Mistakes When Issuing 1099 Forms
There are many difficulties and challenges that can occur when issuing different IRS forms, as the rules can oftentimes be complex. The following are some of the common mistakes that occur when issuing 1099 Forms.
- Including the full name of the contractor on the 1099 Form.
- The correct number (avoiding transposing numbers) for the TIN or EIN or birthdate
- Issuing a 1099 Form to employees, when they should instead receive a W-2 Form at year-end for their wages.
- Issuing a 1099 Form to a corporation. 1099 Forms only need to be issued to independent contractors. If you hire a company to do a service for you, they do not need to be issued a 1099 Form.
- Failing to issue the 1099 Form by the January 31 deadline.
- Sending the wrong 1099 Form copy to the IRS. It is important to note that the IRS will provide five copies of the 1099 Form online. These are for federal tax returns, state tax returns, your records, and the independent contractor. There is also an example of the original one you will need to submit to the IRS, however, it is only an example, and should not be printed or submitted to the IRS directly. If you print and submit this example copy which is in red ink, instead of the correct one, it can lead to IRS penalties.
- Filling out the wrong type of 1099 Form and sending the incorrect one to the IRS. As indicated above, there are several different types of 1099 Form, and if you are submitting a 1099 Form for an independent contractor, you will need to submit a 1099 – MISC Form.
Penalties for Failing to Submit a 1099 Form
If you fail to submit a 1099 Form to the IRS, you may be subject to penalties, and also have reissue them to independent contractors depending on the circumstances. The penalties for failing to file a 1099 accurately and timely are:
- $50 for every tax return (if filed correctly within 30 days after the Jan 31 deadline)
- $100 for every tax return (if filed more than 30 days after the Jan 31 deadline but by August 1)
- $270 for every tax return (if filed after August 1, or not filed at all).
If the IRS discovers that you submitted fraudulent information regarding payments made to another person through a 1099 Form, you may be liable for legal damages and owe compensation. In fact, the worker that you provided an 1099 Form can actually file a legal claim for $5,000 or more in a civil lawsuit.
However, if you can show through evidence that you made errors on the 1099 Form due to events that were completely out of your control, or were based on information that was given to you, you may be able to avoid IRS penalties. You will have to prove that you acted responsibly as a business owner, and what steps you took that you believe ensured that you were paying the correct amount, to the correct persons, and was documented on the 1099 Form. You may also be eligible for decreased IRS penalties if you filed your 1099 Forms timely, even if they were discovered later to be incorrect or have errors.
Best Practices for the W-9 and 1099 Forms
If you are a company that hires independent contractors, you should always as a best practice have them fill out a W-9 on the first day of their hire. This way, this document is obtained immediately and can be used for your legal records and for any tax purposes. An employer does not need to submit this W-9 to the IRS, however, this information is needed in order for the employer to correctly fill out the 1099 Form at the end of the year for the independent contractor regarding their wages. It is important to note that many software packages for payroll make it easy to import data into an electronic 1099 Form.
What to Do if an Independent Contractor Does Not Provide a W-9 Form
If your independent contractor does not provide a W-9 Form, or fails to provide proper information on a W-9 Form, such as the tax identification number or social security number, as a company and an employer, you are then required to withhold 28% of their payment for federal taxes according to IRS regulations. This is very important, as an employer, you do not want to violate any federal laws by hiring an undocumented worker, or incorrectly withholding taxes. Additionally, if you do withhold this 28% for federal taxes, you will need to report this withholding on the appropriate 1099 Form at the end of year.
Contact an Experienced Attorney at Anderson Advisors
Understanding all the tax requirements can be legally complex and challenging for a business owner. Our team of expert bookkeepers at Anderson Advisors can help you make sure that nothing is overlooked and put you in the best possible position at tax time. To talk to a specialist about your bookkeeping needs, schedule a consult today or call 866.896.6141.