Does your business use the services of independent contractors (workers who are self-employed and offer their services to the general public)? If so, you should be familiar with the requirements for dealing with independent contractors for this year’s tax season.
Independent Contractor or Employee?
Because independent contractors have different tax implications than employees and require specific tax forms, it’s important to classify workers correctly. (There are many other reasons to classify workers correctly, including potential monetary penalties for not doing so.) Small-business owners should determine as early in the working relationship as possible whether a worker is considered an independent contractor or an employee.
To determine whether a worker is an independent contractor or an employee, the IRS generally focuses on the relationship between the worker and the business in three main categories:
- Behavioral control, or the level of control a business owner has over how the work is performed.
- The financial control the business has over the business aspects of the worker’s job, including the extent to which the worker has unreimbursed business expenses, the extent of the worker’s investment, and the extent to which the worker can realize a profit or incur a loss.
- The type of relationship that exists between the worker and the employer, such as written contracts and employee benefits like a pension plan, insurance, sick leave, and vacation pay.
Tax Forms to Know
Upon determining a worker’s status as an independent contractor, business owners should request that the contractor complete a Form W-9. This form is used to request the contractor’s taxpayer identification number (TIN); the TIN can be the contractor’s social security number or an employer identification number. This form should be kept on file for four years in case questions arise from either the contractor or the IRS.
IRS Form 1099-MISC is used by businesses to report the total compensation paid to an independent contractor in the previous tax year. This form is filed with the IRS and is also provided to the contractor for reporting income.
Only those independent contractors who were compensated $600 or more for services rendered during the tax year are required to be issued a Form 1099-MISC. Business owners should run a year-end vendor report to determine which independent contractors they paid $600 or more to during the previous tax year, then issue completed Forms 1099-MISC to each qualifying contractor.
When filing Forms 1099-MISC with the IRS, businesses should also file Form 1096, which is used as an annual summary. This form should include the combined totals for all independent contractors paid $600 or more during the previous tax year.
Businesses must file Form 1099-MISC with the IRS by February 28 (March 31, if filed electronically). Business owners are also responsible for providing independent contractors with a copy of Form 1099-MISC by January 31 of the year following payment.
After independent contractors receive their Form 1099-MISC, they have a short window to review the information and compare it with their records to ensure accuracy. If they find any discrepancies, they should work with the business owner until an accurate amount is agreed upon, after which the business must refile a Form 1099-MISC with the “corrected” box checked. Business owners have until March 31 to address discrepancies and resubmit the modified form to the IRS.
What about Subcontractors?
Business owners are not responsible for issuing Forms 1099-MISC to subcontractors. Rather, independent contractors who hire subcontractors to assist with their jobs are responsible for issuing their own Forms 1099-MISC.