No one ever likes it whether on the playground or in the mafia movie.
Nothing good happens to these people.
In the movies, as soon as you see it, you know the character is doomed.
They get a reputation as someone who can’t be trusted at best and “swim with the fishes” at worst.
Rat.
Nark.
Snitch.
Tattletale.
Regardless of the context the terms are never positive. These shifty eyed people are always watching their backs and covering their traces when it comes to their interactions with others.
But every year January rolls around and the IRS mandates that you need to be a tattletale for your business. If that’s not enough, the IRS want you to tattle on the very people who are providing you services!
They don’t call it that, of course, they call it issuing 1099s but it’s the same thing. Unlike the mafia movie, in this game the person penalized is the one who doesn’t tattle.
The US income tax code applies to residents of the US and applies to generally all income. In fact, the IRS says income, “is taxable unless it is specifically exempted by law.” This beautiful premise means any increase in wealth received during the year should by default be thought of as taxable, and you should be prepared to pay taxes on it. (Even buried treasure: if you find treasure, you are required to pay income taxes on it!)
For the IRS to collect taxes, they must first know about income being earned. Employment income is fairly easy. The form W2 for wages is standard for employees and easy to track. Moreover, between quarterly and annual reports the government knows everything about these incomes.
But tracking payments outside the formal employer/employee arrangement is a bit trickier.
That is why in 1918, the US government created a system to track payments from one another outside the employment arrangement, who are generally referred to as independent contractors. For example, if a contractor performs a onetime gig for someone for $1,000, s/he doesn’t get a W-2 because they are not an employee, but in its place they should receive a 1099.
The 1099 is the form created by the IRS to track these payments and chances are you receive multiple 1099s from a variety of sources. 1099-INT come from your bank for interest over $10 for the year, 1099-DIV are sent from your brokerage for dividends received, but the 1099s for business to business are generally the 1099-MISC for “miscellaneous” payments.
The rules are set up to catch the income being paid so the IRS can collect taxes on these payments.
What payments should I include in a 1099 payment?
Now that I’ve scared you about the IRS tracking you down with tax forms, let’s identify exactly what they really want.
In the example above, a contractor performed a service for another person outside of the structure of formal employment once and received $1,000 for their services. This is also known as non-employee compensation. This is one of the hottest items the IRS is looking for.
If you pay individuals more than $600 per year to do services for your company (not purchase products) and they are not employees, they generally need to receive 1099s. And its not just individuals, its non-corporate entities. (This means LLCs taxed as sole proprietors or partnerships and limited partnerships (LPs) should receive them by default.)
How do you know which companies are corporate entities? You ask them. This is ideally done before you initially pay them. Vendors are more motivated to fill out a form before you pay them!
Instruct them fill out a W-9, “Request for Taxpayer Identification Number and Certification” before you send them the first check. This informs you whether they should receive a 1099 in the following January.
Here are some of the rules:
Send a 1099 if you pay a non-corporate entity $600 or more in a calendar year for:
- Non-employee compensation
- Rent (almost all property is held by non-corporate entities)
- Dividends
- Interest (as in a contract purchase)
- Prizes or awards or
- Legal fees
(For a more comprehensive list, check out instructions for Form 1099-MISC.) These forms need to be sent to the recipient by January 31st of the following tax year or else you are on the hook for a penalty.
(Payments made via credit card do not require a 1099 to be sent.)
How much of a penalty depends whether it is a mistake or if it was intentional, the size of your company and whether you are late or negligent. For example, a business with gross revenues under $5 million and not more than 30 days late is potentially subject to only a $50 penalty per missed form.
However, if that same business chooses to disregard those 1099 forms, they can be subject to penalties of $530 per missed 1099! Whether or not the IRS catches these oversights or charges this amount is irrelevant if you’d like to sleep well at night. They’ve made their point and they want to know how much you’re sending to your business partners.
There are four steps to take before January 31st:
- Review the list of vendors you paid in the prior year. Specifically, identify those who were paid for a service (not a product).
- Identify whether those vendors are taxed as corporations. Do this by calling them and/or having them fill out a form W-9 for you.
- Double check the amounts you sent them in the calendar year and ensure the numbers are correct.
- Send them the appropriate 1099 by January 31st.
Just one other word of caution here; just like your parents taught you, tattling isn’t nice and no one wants to be on the receiving side of this. Make sure your numbers are correct before you rat out your business partners to the IRS. Many a business owner becomes grumpy in January because of 1099s, even when they are correct!
When you do receive a cantankerous call from your service providers about a sent 1099, remember that a calm word turns away wrath. You are only trying to be compliant and avoid penalties yourself.
Sending 1099s is part of the annual recurring tasks keeping your company compliant with the IRS. If managed well throughout the year, this can save hours in January. Regardless, of how long they take though, they need to be done in January to avoid penalties.