IRS 1099-MISC: Your IRS reporting obligations to independent contractors and other non-employees
By Andrew DeWeese and Calvin Eib
Originally published in Marijuana Venture, April 2015
Who must report. What must be reported. Key Deadlines. Penalties
Whenever your business contracts with another business or individual, it’s worth considering how the IRS views the arrangement and your reporting requirements associated with making payments to that business or individual.
The IRS considers an independent contractor to be self-employed and subject to self-employment taxes, whereas an employee is subject to withholding and reporting for income taxes, Social Security & Medicare. Thus, even though you may not have an employer-employee relationship with your favorite cannabis farmer, you may still have an IRS reporting obligation for payments you make to that business.
When is an individual or business considered an independent contractor?
Individuals who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. If your dispensary business hires or contracts with a cannabis farmer to grow and provide product, then you need determine specifically the nature of that business-to-business relationship for federal tax reporting purposes.
An individual is an independent contractor if you have the right to control or direct only the result of the work and not how that result will be obtained. However, an individual will usually be considered an employee if you have the legal right to control the details of how the services are performed – that is, not just what will be done, but how it will be done.
This determination is based on all the relevant facts and circumstances. It’s important to consider the entire relationship, analyze the degree or extent of your right to direct and control, and to document each of three following factors: (1) Behavioral (your company’s control or right to control what the worker does and how the worker does his or her job); (2) Financial (your company’s control or right to control business aspects of the worker’s job, such as how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.); and (3) Type of Relationship (such as a written contract or employee benefits such as pension plan, insurance, vacation pay, etc.; and whether the relationship continue and whether the work performed a key aspect of your business).
For example, assume a medical cannabis dispensary has an agreement with a cannabis farmer to supply certain types of cannabis, in certain amounts and of a particular quality. The cannabis farmer determines when and where to do the growing, what farming tools and equipment will be used, the number of workers to hire to assist with the work, which worker will perform specific tasks, and generally retains the right to determine the details of the farming work in order to supply the cannabis. Given these facts, it is likely that the cannabis farmer is an independent contractor. But it is important to look at all the facts since there is no specific number of factors that makes the cannabis farmer an employee or an independent contractor. The keys are to (1) look at the entire relationship, (2) consider the degree or extent of the right to direct and control, and (3) to document each of the factors used in coming up with your determination.
Payments you make to independent contractors in the course of your trade or business
If you made payments totaling $600 or more to an independent contractor during the year in the course of your trade or business then you must report those payments to the IRS, and send a copy to the person or business you paid. These reportable payments include payments for services performed, as well as any associated materials provided.
Exceptions for certain types of payments
Certain payments you make in the course of your trade or business are not required to be reported to the IRS. These include:
- Payments for merchandise (when no service is included in the purchase; but when services and merchandise are purchased together, err on the side of caution and report)
- Payments made to a corporation (including an LLC that is treated as a C or S corporation)
- Payments made using a credit card or payment card and certain other types of payments, including third party network transactions (which must be reported on Form 1099-K by the payment settlement entity)
- Payments for rent if it is paid to a real estate agent
If you expect to pay a business more than $600 then you should have them fill out a Form W-9, which will provide you with their Tax ID number (“TIN”), business structure (sole proprietor, C corporation, etc.) and their address.
Deadlines and penalties
Form 1099 must be filed by the end of February with the IRS. If the form is filed late, incorrectly (such as a missing or incorrect tax identification number for the person/company you paid) or not filed at all, then you may be subject to penalties and/or an audit of your reporting practices.
If the 1099 is late-filed between March 1 and March 31, the penalty is $30 for each failure, up to a maximum penalty of $250,000 per year. This penalty is capped at an annual total of $75,000 for “small businesses,” which are defined as a business having average annual gross receipts of $5 million or less over the 3 most recent tax years (or for the period the business was in existence, if shorter).
If the 1099 is late-filed between April 1 and July 31, then the penalty is $60 per failure (maximum penalty $500,000 per year or $200,000 for small businesses).
If the 1099 is late filed after August 1, then the penalty is $100 per failure penalty (maximum penalty $1,500,000 per year or $500,000 for a small business).
If the 1099 is not filed at all such that the IRS determines it was “intentionally disregarded,” then the penalty is $250 per failure (with an IRS audit likely imminent).
Anyone who receives a 1099 should take care to include that information on their tax return. The IRS matches the 1099 it received from the payor with the item that should appear on the payee/independent contractor’s tax return via the payee’s tax identification number. In order to help ensure that businesses receive 1099s and any other IRS-related correspondence, beginning January 1, 2014, the IRS requires that any entity with an employer identification number (EIN) must report to the IRS a change to its business address, business location or “responsible party” (such as its principle officer or managing partner, etc.) via Form 8822-B.
Whenever you contract out with another business or individual, it’s worth considering the nature of that relationship, how the IRS views the arrangement, and to set up the proper IRS reporting for payments that you will make to that business or individual. It will save you time in the long run and help avoid a highly preventable IRS audit of your reporting practices.