Non-Employee Compensation: Definition & Compensation Reporting

Non-Employee Compensation: Definition & Compensation Reporting
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The Internal Revenue Service made a change in the way you must report non-employee compensation beginning with tax year 2020. Non-employee compensation was reported on Form 1099-MISC through 2019, but the IRS then redesigned and reinstated an old form that was last used in 1982: Form 1099-NEC.

The passage of the Protecting Americans from Tax Hikes Act in 2015 created some confusion about filing deadlines when business owners were reporting non-employee compensation on Form 1099-MISC. The IRS decided to take the reporting of non-employee compensation out of 1099-MISC and report it separately on the new version of Form 1099-NEC to clarify the situation.

Read More:What Is Form 1099-NEC?

When Must You File a Form 1099-NEC?

You must file a Form 1099-NEC if you made payments in excess of $600 for services in the normal activities of your trade or business:

  • To someone who is not employed in your business and is working as an independent contractor
  • To an individual, partnership, estate, or, in some circumstances, a corporation

What is an Independent Contractor?

An independent contractor as an entity or person who performs services for another entity or person and is paid per a contractual agreement. Independent contractors provide their own equipment and decide for themselves when and where they'll perform the work. Unlike regular full-time employees, they don't receive benefits such as health insurance and retirement plans. They're not entitled to worker’s compensation coverage.

They are most commonly self-employed vendors such as website developers, graphic designers, construction workers, consultants, accountants or real estate agents.

How to File Form 1099-NEC

You must get a W-9 form from the independent contractor because it contains the information you'll need to complete a Form 1099-NEC for them at year's end.

A 1099-NEC has five parts:

  • Payer’s data: Enter the payer’s name, address and tax ID number.
  • Recipient’s data: Enter the recipient’s name, address and tax ID number. A recipient that fails or is unable to provide a tax ID number should arouse suspicion.
  • Amount of non-employee compensation: Enter the amount of the recipient’s compensation for the past year in Box 1.
  • Federal income tax withheld: You would not normally withhold federal income taxes from payments made to independent contractors. The only time you would withhold any taxes would be if you've received a backup withholding order from the IRS. Enter the amount withheld, if any, in Box 4.
  • State data: Use boxes 5, 6 and 7 for any state withholding and state data. Report the total on the 1099-NEC if the recipient must pay sales tax, and if you pay these taxes in addition to these charges to the recipient.

Read More:How to Read a 1099-NEC

What About Corporations?

You would not normally file a 1099-NEC when making payments to C Corps or S Corps, but there are exceptions. You would file a 1099-NEC for a recipient if their Form W-9 indicates that the entity is an LLC and is taxed as a sole proprietorship,

The exemption for not filing a 1099-NEC for corporations does not apply to attorneys. Payments to lawyers for legal services, whether a corporation or individual, must be reported as total compensation in Box 1.

Non-employee compensation for independent contractors is reported on a 1099-NEC with copies to the IRS and recipient by Jan. 31.

Fishing Activities Have Special Rules

You must report all payments made in cash over $600 in a year to a person or entity engaged in catching fish if your business involves purchasing fish for resale. The IRS requires that you keep records for the dates and amounts of each cash payment, but you need only report the total payments for the year.

The IRS defines “cash” as U.S. and foreign coin and currency, a cashier's check, money order, bank draft or traveler's checks. Checks written on your personal or business checking account are not considered to be cash payments.

Other Items That Should be Reported on 1099-NEC

These are examples of a few items that should also be reported on a 1099-NEC:

  • Directors’ fees: Fees and other remuneration to directors, even payments made after retirement, should be reported in Box 1.
  • Payments to commission-only salespeople: Any advances made to non-employee salespeople on future commissions and subject to repayment that are not earned or repaid during the year must be reported as compensation in Box 1.
  • Payments for parts and materials: Payments should be included in Box 1 along with the payment for services provided if you paid for any parts and materials that the independent contractor needed to perform their services.
  • Fee splitting: Report fees paid by one professional to another professional per a fee-sharing agreement.
  • Fees paid to experts or witnesses in legal matters: Attorneys will occasionally hire legal experts or witnesses to testify in legal cases. These payments are reported on a 1099-NEC.

What to Do and Not Do with Form 1099-NEC

You must have a Form W-9 from each independent contractor and verify that the taxpayer ID is correct before you can complete a Form 1099-NEC.

Do not use a 1099-NEC to report any personal payments.

Do not report gross proceeds from settlements or lawsuit claims, not fees, paid to an attorney. Instead, use Form 1099-MISC.

Do not report rental payments made to real estate agents or property managers on a 1099-NEC. These should be reported on Form 1099-MISC.

Do not report employee wages on a 1099-NEC. Report employee wages on a Form W-2.

Do not use Form 1099-NEC to report employee business expense reimbursements. If you have a non-accountable plan for your employees, report reimbursement payments as wages on Form W-2.

You’ll have to file another form, a 1099-NEC, to report non-employee compensation beginning in tax year 2020 and going forward. You may still have to file a 1099-MISC for items such as rent payments, royalties or prizes, but 1099-NEC will be used exclusively for non-employee compensation.