1099-MISC: Who should receive them, why proper classification is essential, and how to remediate errors
Form 1099-MISC is due to vendors by Jan. 31 for payments made the preceding year to non-corporate independent contractors. The IRS requires form W-9 to be completed before any payment is made to a vendor. Businesses do NOT have to issue a 1099 to any vendor that indicates on the Form W-9 that they are a corporation unless the payments were to an attorney.
Employee or Contractor?
To determine if an individual is an employee or an independent contractor, consider the IRS 3-Factor Test:
The Behavioral Test: Does the company control or have the right to control what the worker does and how to do get it done? Examples include matters such as when to arrive at the office, how to do the job, when to break, etc. If the company controls these matters, the individual is an employee.
The Financial Test: Who controls the economics of the worker’s job? Factors suggesting employee status include payment on a regular timely basis (such as monthly), payment based on hours worked, and eligibility for reimbursement of travel costs. Factors suggestive of contractor status include the ability to work for more than one firm, providing one’s own tools, and often a flat-fee arrangement.
The Relationship Test: How does the worker and the business perceive their interaction with one another? Evidence of an employer-employee situation include the opportunity to take advantage of retirement benefits and PTO, for example. The permanency of the relationship should also be considered. An independent contractor is often project-oriented whereas an employee is often hired to render services indefinitely. A written contract stating that the worker will be treated as an independent contractor is not the sole factor in determining the worker’s status.
Late, mistaken and unfiled Forms W-2 and 1099 incur substantial penalties. In most cases, the penalty is $250 per infraction, with maximum penalties of up to $1.5 million. This change, along with payroll tax penalties exceeding 100% for misclassified employees, makes obvious Congress’ intent to address misclassified employees and for the IRS to increase enforcement of classifying rules.
Heed your tax professional’s advice when it comes to classifying employees/independent contractors, especially given the dramatic increase in penalties.
Take a Closer Look
Due to the excessive penalties associated with misclassifying a worker, we strongly recommend that you closely examine every relationship you have with an independent contractor. Should you encounter a classification error – in the past or in the future – there is a program for resolving issues.
The Voluntary Classification Settlement Program or VCSP, is able to offer certain eligible businesses the option to reclassify their workers as employees with partial relief from federal employment taxes. Under this program, the employer identifies those people that have been mistakenly classified as independent contractors previously, asserts that the worker(s) will be treated as W-2 employees moving forward, and pays a small penalty on the employment taxes that should have been paid in the prior year.
At SIMA, we routinely encounter classification questions and are prepared to walk employers through the 3-Factor test to ensure compliance with the law and to support you through rectifying errors should they be discovered.
For further information, consult IRS guidance here. If you have any questions, please don’t hesitate to contact us.