When to use the Form 1099-NEC
Independent Contractors - Non Employee Compensation Requirements

Published June 8, 2024 | Updated November 30, 2024

WHAT'S IN THIS ARTICLE
Difference between 1099-NEC vc 1099-K vs 1099-MISC | Form 1099 thresholds | Completing 1099 forms | Form 1099-NEC Highlights | Form 1099-K Highlights | Form 1099-MISC Highlights | How Commercial Contractor Registration and W-9 affect 1099 forms | FAQ About 1099 Reporting | Key Takeaways

IRS Form 1099-NEC vs 1099-MISC vs 1099-K: What's The Difference

Generally a 1099 form is an IRS tax form that documents payments made a business, an individual, or an entity that is not an employee. Your task, as a small business owner, is to figure out the correct 1099 to file with the IRS by January 31st each year.

IRS introduced the form 1099-NEC Non Employee Compensation for the 2020 reporting of independent contractors compensation paid. Previously it had been reported in Box 7 of the Form 1099-MISC Miscellaneous Information. It can get confusing when you also consider the Form 1099-K Payment Card and Third-Party Network Transactions introduced in 2012.

Let's chat about the reporting requirements for non-employee compensation. If you are unsure whether someone is considered an employee or an independent contractor, please read my chat on the topic as it is a frequently audited area. A mistake in classification could be very costly to the employer.

Form 1099 Thresholds Are Changing

1. Implementation of The American Rescue Plan Act of 2021 legislation was delayed two years in a row. The IRS issued Notice 2024-85 on November 26, 2024 providing guidance on transition relief for TPSOs (third-party settlement organizations). They are also known as payment apps and online marketplaces.

The notice provides that TPSOs will be required to report transactions on Form 1099-K when the gross amount of aggregate payments for those transactions, irrespective of the number of transactions, is more than:

• $5,000 in calendar year 2024
• $2,500 in calendar year 2025
• $600 in calendar year 2026 and after

2. H.R. (House of Representatives) 7024 Tax Relief for American Families and Workers Act of 2024 passed in January 2024 and has now gone to the Senate. On August 1, 2024, the broad tax bill finally reached the Senate floor, but a vote to end debate failed, 48-44, largely on party lines. It is doubtful it will pass before the November elections. If passed into law, the thresholds for:

• 1099-MISC and 1099-NEC will change from $600 to $1,000 for payments made in 2024. Future years would be tied to inflation.
• Direct sales threshold would change form $5,000 to $1,000.

Why Does The IRS Require A Form 1099-NEC?

Under current law, only payments for services to any person engaged in business or trade that aggregated to $600 plus per year are reported. Until 2020 (2019 tax year), this income was reported on various 1099s including the 1099-MISC and 1099-K. The IRS introduced the 1099-NEC in 2021 for the 2020 tax year but implementation has been delayed for 2022, 2023 and probably 2024 as the Senate had not passed the bill as of November 2024.

One of the ways the IRS audits independent contractors is through the 1099 matching program. The IRS began matching Form 1099s to business returns to find underreported income. The matching was done after refunds had been issued. As refund fraud increased, the issue was addressed by the 2015 PATH (Protecting Americans from Tax Hikes) Act to fight against it. 

In 2017, the IRS began scrutinizing income reported by matching it to 1099s filed before they issued a refund. This quick audit method is low hanging fruit and easy to audit thereby decreasing refund fraud while increasing its enforcement and assisting with the filing of more accurate tax returns. To allow for upfront matching, the IRS changed the required 1099s to be filed by January 31st instead of February 28th.

Letter CP2000 Notification of Underreported Income is sent if the information is mismatched. Find out why you received the notice and how to proceed before you reply.

Who Should Receive the 1099-NEC?

Here is a brief overview of 3 general rules about who should receive the 1099-NEC:

General Rule #1 Services Only: 

Only required for services delivered, NOT product or materials, to your business are reported. This means (a) personal payments (such as birthday or holiday gifts, sharing the cost of a car ride or meal, or paying a family member or another for a household bill) and (b) wages to employees are not reported here.

General Rule #2 More Than $600:

Only payments that total $600 or more that were PAID DIRECTLY TO AN INDIVIDUAL are reported. An individual would be a sole proprietor, independent contractor, freelancer, a self-employed person, consultant, or a vendor.

In addition, any suppliers who do not file a corporate return are reportable. You need to ensure you have a W-9 on file to determine if an LLC requires a 1099-NEC or not because they have the option to file as a sole proprietor / partnership or as an S-Corp.

General Rule #3 Paid Through Bank: 

Only payments made by cash or payments made through your bank account such as cheques, debits or ACH are reportable. 

Exception to the Rules:

Avalara*, experts in sales and use tax, explains that "Form 1099-NEC (or the 1099-MISC but not both) can also be used to “report sales totalling $5,000 or more of consumer products to a person on a buy-sell, a deposit-commission, or other commission basis for resale.”

General Rule*:

 Issue Form 1099-NEC to all law firms, regardless of their tax filing status

*Source: House approves new thresholds for 1099 forms by Gail Cole; 1099 Rules for Attorneys and Law Firms by LawPay

Who Should Not Receive the 1099-NEC?

• Payments to corporations are not reported on the 1099-NEC; this includes LLC, S Corps, and C Corps.
• Wages paid to employees
• Employee business travel allowances paid under an non-accountable plan (this goes on W-2 and is subject to applicable federal employment taxes)
• Expense reimbursement under an accountable plan are not taxable or reportable
• Freight, storage, or merchandise payments
• Real estate agents are not considered individuals for these purposes so do NOT report rent paid to real estate agents.
• Commercial Contractor Registration or W-9 (captures TIN (taxpayer identification number), etc. when a person or entity is required to report certain types of income)
• Payments made through a third party provider such PayPal, Venmo, or a credit card provider will be captured on Form 1099-K by the third party. You do not need to report amounts under the 1099-K threshold is 200 transactions and at least $20,000 in total payments. 

1099-NEC Yearend Tax Compliance Reminder
for Independent Contractors 

• As of the 2020 tax year, you now use Form 1099-NEC to report independent contractor payments instead of the Form 1099-MISC (box 7) as in prior years.
• Form 1099-NEC should be presented to service contractors before February 1, 2021. IRS receives Copy A, the contractor receives Copy B, and you retain Copy C for your records to support your subcontractor expenses.
• You may file the forms using a truncated taxpayer identification numbers (TTIN) ... the first five digits are replaced with an "x" or "*" ... to prevent identity theft.
• The IRS receives Form 1096 Annual Summary and Transmittal of U.S. Information Returns AND Copy A by March 1 ... March 31 if filed electronically.
• To send the 1099s by email requires the explicit permission of the contractor.
• Annual Return Form 945 Withheld FIT is used to report non payroll payments including WFIT on Form 1099 is also due January 31, 2021.

As Robert Wood, tax lawyer and Forbes columnist likes to say, "It's better to give than receive." :)

Source: The Bookkeeper's Notes Newsletter

How The IRS Knows You Didn't Report Income

The IRS has many ways to determine if they suspect you have unreported income. Here are a few:

• Information statement matching where forms 1099, W-2, etc are matched to your personal income tax returns filed with IRS.
• Comparing your business financial ratios with similar businesses. (Check out BizStats to see how your business compares.)
• Website e-commerce activity are matched to 1099-K forms are matched to your business income reported and filed with the IRS.
• Bank deposit analysis where they look at all the monies deposited to you and your family members' bank accounts.
• Lifestyle audits, also sometimes referred to as T-account analysis, where they compare reported income to personal expenditures. It's not good for you if they resort to this type of audit.

In 2012, they targeted unreported online income by introducing the Form 1099-K Payment Card and Third-Party Network Transactions. The legislation for this was enacted in 2008. Processors of credit card and debit cards such as Visa and Master Card as well as electronic payment systems like PayPal and Venmo are required to report the gross receipts of payments made to businesses. This reporting did not affect cash receipts.

As mentioned earlier, this is a quick audit method that catches low hanging fruit. It is easy to audit which decreases refund fraud and increases its enforcement. This matching program assists with the filing of more accurate tax returns.

What Is The Form 1099-K and Who Should Receive?

Prior to 2025, the form 1099-K Payment Card and Third Party Network Transactions details payments received through payment card transactions and third-party network transactions was issued if you met or exceeded both 200 transactions and $20,000 in gross total reportable payment volume.

On November 26, 2024, the IRS issued transition guidance for new thresholds for the form 1099-K. They are: $5,000 in 2024, $2,500 in 2025, and $600 in 2026 and thereafter irrespective of the number of transactions. This means if you receive payment card transactions or third-party network transactions totalling to the new thresholds or more in a calendar year, you'll receive a Form 1099-K.

It’s generally filed by third-party payment processors like PayPal, Stripe, or Square. If you’re a business owner that has receives online payments, you’ll receive a 1099-K form each year, summarizing your transaction details if you exceed the stated thresholds. 

This change was designed to improve tax compliance and ensure that income received through such TPSO platforms are reported accurately to the IRS. As a small business owner, you should prepare for these reporting requirements, as they may impact how you track and report income. Additionally, it's extremely important to keep accurate records of all your transactions to ensure you are reporting your income correctly.

Takeaway
Filing is typically handled by the payment processing service. As a merchant, ensure your business information is up-to-date in these services to receive accurate and timely forms.

If you haven't already done so, it might be a good idea to reach out to your accountant or a tax professional to make sure you're clear on what to expect and how to handle any issues that might arise from these new thresholds for the 1099-K.

What To Do If You Receive A 1099-K?

If you receive a 1099-K, insure these amounts are included in your income to the IRS.

What Is The Form 1099-MISC and Who Should Receive?

The form 1099-MISC Miscellaneous Income used to be used for reporting of independent contractors compensation paid. Since 2020, these payments are now reported on Form 1099-NEC. This reporting change did not make the 1099-MISC go away. It is still used for various forms of alternative income like rents, prizes, awards, healthcare payments, and other payments not involved with non-employee compensation.

You need to file Form 1099-MISC for each person from whom you have withheld any federal income tax under the backup withholding rules regardless of the amount, or for whom you have paid at least $10 in royalties or $600 in rents, services (other than nonemployee compensation), prizes, awards, or other income payments.

Filing can be filed by paper or electronically. Check whether your specific payer software supports electronic submissions to simplify the process.

What To Do If You Receive a 1099-MISC?

As with the other 1099 forms, if you receive a 1099-MISC, insure these amounts are included on the appropriate line when filing your income tax return with the IRS.

What is a W-9?

This form is used by businesses to gather information from contractors, freelancers, or vendors from whom they will need to report payments for federal tax purposes.

When a business entity hires these non-employees, they are required to fill out a W-9, which provides the business with necessary details such as the contractor's name, address, and Taxpayer Identification Number (TIN), which is typically a Social Security Number (SSN) or Employer Identification Number (EIN).

More >> Form W-9 and Form 1099-NEC

For individuals, such as freelancers or contractors, who complete a W-9, the information provided is used by the business to file a 1099 form. For example, Form 1099-NEC is used to report payments of $600 or more in the course of the year to a non-employee.

Their completion of the W-9 should provide doucumentation to prove if the entity is exempt from a 1099-NEC filing.

In practice, both a W-9 and a 1099-NEC are usually necessary for the reporting process but serve different roles. The W-9 is used to collect the needed identification data, which is subsequently used to fill out and submit a 1099-NEC when it comes time to report payments made.

What is Commercial Contractor Registration?

This term usually refers to a required registration process for contractors who work for commercial entities, often regulated at the state level.

The specific rules and requirements varies depending on the state. Typically, this involves registering with a state contractor's board or similar regulatory body, often necessary for legal operation and bidding on contracts.

The Commercial Contractor Registration in itself doesn't directly interact with IRS forms like W-9 and 1099. However, maintaining proper registration and compliance affects a contractor’s business operations, including their eligibility to receive payments, which in turn, require reporting through IRS forms.

Contractors must be registered (where necessary) and compliant to facilitate their tax obligations, such as those involving the submission of Form 1099s by their clients based on the information provided in W-9 forms. Their registration should show if the entity is exempt from a 1099-NEC filing.

These Q&A are a direct excerpt from the "Common Questions" section of an IRS 2011 webinar on Form 1099 Reporting for Federal Agencies. I believe the responses provided are still valid in 2024.

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