There have been many changes in 2020 and with the rise of the gig economy. The 1099 Form has been changed since then.
What Has Changed in 2020 for the 1099 Form?
IRS has created a separate form since 2020 to report independent contractor payments. Henceforth, independent contractor payments are reported in form 1099-NEC which you would earlier report in 1099-Misc.
If you’re new to this, NEC stands for Non-Employee Compensation which is payments for Independent Contractors. For instance, before this change, independent contractor payments used to be reported in Box 7 of 1099-misc.
Are there any changes in 1099 for tax years 2022 and 2023?
There are a few changes in the 1099s Forms in 2022. A new box, box number 13, has been added to the form. This new box has been assigned to Foreign Account Tax Compliance Act ( FATCA). Old box numbers 13 to 17 have been to new box numbers.
Another change is the continuous-use form, which means the year on the form won’t change every year.
Why do You Need a 1099 Form?
If you or your business has hired an independent contractor and paid them over $600 during the financial year, you need the 1099 form. The last date to file your 1099s is January 31st.
Who is an Independent Contractor?
Independent Contractors are individuals who perform work for an entity but they are not employees. IRS defines Independent Contractors as “an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.
Independent Contractors vs. Employees
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An employer must have a reasonable basis to classify a worker as an IC. Misclassifying a worker as an IC can have costly consequences for the employer. To understand the difference, you need to look at several factors.
The main difference between employees and independent contractors is in the benefits that they receive. An employee receives a regular wage, benefits like healthcare, and worker compensation.
On the other hand, an independent contractor is hired for a particular project. For this reason, the employer is not responsible for the benefits listed above and only has to pay what the contract states.
Difference between an Independent Contractor and Employee
There are the following 3 main IRS tests to decide if a worker is an IC or an employee.
- Behavioral Control: if the work is performed without any direction or control by the business, the worker can be classified as IC. For example; an IC decides where and when to perform the work, and which tools to use to complete the job.
- Financial Control: IC has the opportunity to generate profit or loss from the job to be performed. An IC does not usually get reimbursed for the expenses accrued for the project.
- Relationship: You usually hire an IC for a project, not as a permanent employee.
How does the IRS classify the ICs differently than the States?
Even though the IRS has strictly classified employees and nonemployees, IRS and some states may have a different approach to classifying a worker as IC.
IRS accepts common employment law and based on common law, a worker is an IC if the employer has no or limited control over the worker. If you cannot determine how to classify the worker, you can fill out the IRS Form SS-8 and summate to the IRS. Based on the information on the form, the IRS will decide which class the worker belongs to. IRS has also set 20 factors (Revenue Ruling 87-41) to determine exemptions for employee classifications.
On the other hand, some states may have different criteria for that. In California, since September 2019, Assembly Bill (AB) 5 requires any worker to be classified as an employee if the following conditions are not met:
- Free from control
- Outside the usual course of the hiring entity’s business
- The worker provides the same service to other clients
However, the following types of workers are excluded;
- Media-related freelancers
- App-based drivers and contractors
On the other hand, Virginia (Virginia Employment Commission) applies the 20 factors set forth by the IRS. Based on employment law, a worker is an employee if the following conditions apply;
- Furnishes tools, materials, and equipment needed to do the work;
- Sets the hours of work;
- Withholds payroll federal and state income taxes and Social Security taxes;
- Receives direction and training from the employer about how to do the work; and
- Is paid by the hour, week, or month instead of being paid at the completion of a job.
Benefits of Independent Contractor and reporting payments in 1099-NEC
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- No self-employment taxes (FICO) are paid by the entity
- No unemployment taxes
- Less admin work and expenses since you don’t need to process payroll.
- No minimum wage requirements
- No equal pay requirement
It is important to classify and report worker payments accurately in order to avoid penalties from the IRS and other regulatory agencies. As the gig economy grows and freelancing expands, it is important to pay special attention to the accurate classification of a worker. An employer should keep the following documents from an IC.
- Business cards
- Professional license
- W-9 form
- Contractor agreement that outlines the work scope clearly
Dangers of Filing the Wrong Form
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We get it, the filing date is nearing and you’re in a hurry to file the 1099 form with changes for 2020. However, a small mistake can incur big penalties if you’re not careful. If you’re in doubt, you should always ask a professional to avoid misclassifying.
The penalties depend on the size of your business, the number of errors, and also on how late you file your taxes.
Similarly, you will also face penalties if you give a 1099 form to an employee who should receive a W-2 form. Misclassifying an employee as an independent contractor attracts higher penalties than the other way around. Hence, it’s important that you correctly identify your independent contractors and employees to ensure that they receive the right form.