It’s that time of year, when employers must issue tax forms to their employees for the previous year’s activities. And you’d better jump to it, because the deadline to get these in the mail is January 31st.
The first issue you must consider, when evaluating what forms are required, is whether the person who worked for you is an employee or an independent contractor. There’s a huge difference, and you might be tempted to classify people as “contractors” to avoid the more complicated paperwork required for employees. But be careful when making this distinction; even Microsoft found out the hard way that the IRS does not look kindly on mis-classification.
According to the IRS guidelines, there are actually 4 different types of workers who may provide services to your small business: employees, independent contractors, statutory employees, and statutory nonemployees. The last two are pretty rare, so you probably need to concern yourself only with the distinction between the first two.
The IRS defines a person as 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.” In other words, if your workers provide you the end result of their service, without you directing how, when, or where they perform that work, then they can safely be classified as independent contractors.
There are three categories of evidence that the IRS considers when determining that a worker is an employee:
Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
Financial: Are the business aspects of the worker’s job controlled by the payer? (These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Employees essentially provide their services at your direction – when, where, and how, generally using your equipment and/or tools. So if you have workers who come to your offices and use your computers, you must classify them as employees, and you must withhold payroll taxes and adhere to the other employer-employee requirements.
Note, however, that there are other employment situations that you may encounter, that may or may not require a 1099. If you use the services of a placement agency to find your workers for you, then you are merely paying the agency its fees, and not directly employing the workers. The agency will be responsible for taking care of its employees’ tax filings. Likewise, if you hire a plumber or carpenter to do work on your office, you are paying the construction business, not the workers individually. If you hire a cleaning service to clean your office, you may pay a company, if the cleaner is hired through an agency, or you may have an independent contractor, if you hire the cleaner and pay him or her directly.
Once you’ve decided which type of worker you have, then it’s easy to determine which type of form you must file with the IRS and provide a copy to your worker.
A W-2 is provided for employees. If you have employees, then you should have them already enrolled in a payroll software system, which has been deducting their taxes from their paychecks and prompting you to pay the required withholding to the IRS quarterly. These software systems will be able to generate the W-2s that you need to provide to your employees.
If you have independent contractors who provide services for your business, however, then you have a couple of other issues to determine before you issue 1099s.
Firstly, you will most likely be issuing a 1099-MISC to your contractors. There are other types of 1099 forms, but they apply to a variety of different issues and do not apply to people who provide services for you.
There are minimum requirements that must be met before you are required to issue a 1099-MISC. This requirement is a total of $600 paid to a contractor over the course of the year. So if you paid less than $600 to an individual contractor, you can skip issuing the 1099. (This does not relieve the contractor from including the amount of payment received from you with his individual tax filing, but that is not your responsibility.)
If you do have to issue a 1099-MISC to one or more contractors, you have until January 31st to send out the contractor’s copy. (The IRS says the contractor has to receive it by the 31st, but as long as you postmark it by the 31st, you should be OK. Check with a tax lawyer to be sure, though.) You then have until February 28th to file your copy with the IRS.
An annoying note about 1099s – the copy that you file with the IRS cannot be generated from your software accounting system. You can prepare the contractor copies online, or from a PDF from the IRS. But the official copy, the one that you send to the IRS, must be on special IRS paper. You can either obtain these by ordering from the IRS, or they can often be found at office supply stores.
OK, another form? Yes, unfortunately. Form 1096 is a summary of all of the 1099s that you filed, and it must be filed with the IRS with the copies of the 1099s by February 28th.
This process doesn’t have to be a complete nightmare. As long as you kept reasonably good financial records during the year, you can probably do it yourself, if you only have a few. Or, turn it all over to a good CPA and let them do it for you, if you have a lot of 1099-MISC forms to issue. Most of them can do this quickly and easily, leaving you free to focus on your strengths – building your business and making money.
Brad Hanks is in charge of Growth at ZipBooks.