If you're a startup founder or an entrepreneur frequently engaging with independent contractors or freelancers for services, you should familiarize yourself with the Internal Revenue Service's (IRS) Form 1099-NEC.

Understanding Form 1099-NEC – The Basics

Form 1099-NEC is a tax document introduced by the IRS in 2020 to report non-employee compensation. Previously, such payments were noted in Box 7 on Form 1099-MISC. However, the introduction of the 1099-NEC didn't eliminate the 1099-MISC form, which is still utilized for reporting various payments, including prizes, awards, rents, royalties, and gross proceeds paid to attorneys.

Decoding Non-employee Compensation

Simply put, non-employee compensation refers to payments made to an independent contractor or freelancer who provides services for your business in course of trade. Included in this definition are fees, commissions, and other forms of compensation (including parts and materials).

Contrary to wages paid to an employee, payments to non-employees do not have tax or payroll withholdings. The independent contractor is responsible for settling their income taxes, Social Security, or Medicare taxes. Instead of issuing W-2 forms, as done for employees, you are required to provide them with a 1099 NEC form, showing total payments made during the previous year.

Who Should File Form 1099-NEC?

Businesses are required to file a 1099 NEC form for each independent contractor if the following conditions are met:

  • The payee is not your employee.
  • Compensation was made for services related to your business operations.
  • Payment was made to either an individual, single-member LLC, partnership, or LLC taxed as a partnership. Typically corporations do not receive 1099-NEC forms, but there are some exceptions such as medical and health care payments and payments to an attorney.
  • Total compensation over the tax year equaled or exceeded $600.

If you withheld federal income tax from non-employee compensations under the backup withholding rules, regardless of the total amount paid, you'll need to file a Form 1099-NEC.

When Should A 1099 NEC Be Filed?

Currently, you must submit Copy B of the Form 1099 NEC to all payees and file Copy A with the IRS by January 31 of the following year. You can do this either electronically or by using paper copies. If the due date falls on a holiday or a weekend, the deadline will be moved to the next business day. Be warned, submit on time or potentially face fees of up to $630 per form for late submissions. Important to note the IRS also charges interest on penalties.

How to Fill Out Form 1099-NEC

Although IRS forms might seem daunting, the Form 1099-NEC is relatively straightforward. Here's what you'll need:

  • Your company's contact information and taxpayer identification number.
  • The payee's contact information, taxpayer identification number, and an account number if applicable.
  • Total non-employee compensation paid during the tax year.
  • Federal income tax withheld, which is usually zero unless backup withholding rules are applicable.
  • State-specific information such as state income tax withheld (if applicable), the payee's state identification number, and the corresponding non-employee compensation.

Form 1099-NEC vs. 1099-MISC

Although the 1099-NEC returned in 2020, it has been around since the 1980s, where it was used to report independent contractor payments. However, the IRS transferred this information to Form 1099-MISC from 1983 - 2019. So, while 1099-NEC now exclusively handles non-employee compensations, 1099-MISC is still used for reporting other payments, like rents, royalties, or prizes.

The Key Takeaway

It's prudent to collect IRS Form W-9 on hand before issuing any payment to a contractor. The W-9 form helps gather each payee’s complete contact information, taxpayer identification number, and business structure, facilitating easier and more accurate 1099-NEC filings.

Whether you're required to issue a 1099-NEC or you're expecting to receive one, it's essential to maintain accurate and updated financial records. With organized financial documents, your year-end tax filing process will be a breeze, and you'll be well equipped to comply fully with the 1099 requirements.