Non-Employee Compensation: Definition & Compensation Reporting

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The Internal Revenue Service has made a recent change in the way you report non-employee compensation for the upcoming 2020 tax year. In past years, non-employee compensation has been reported on Form 1099 MISC, but the IRS has redesigned and reinstated an old form that was last used in 1982 known as Form 1099-NEC.

In recent years, business owners used Form 1099-MISC to report non-employee compensation, but the passage of the Protecting Americans from Tax Hikes Act in 2015 created some confusion about filing deadlines. To clarify this situation, 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.

Henceforth, non-employee compensation for independent contractors will be reported on a 1099-NEC with copies to the IRS and recipient by Jan. 31.

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?

Law.com defines 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 to perform the work. Unlike regular full-time employees, they do not receive benefits such as health insurance and retirement plans and are 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 has the information you will need to complete a Form 1099-NEC.

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 – Normally, you would not withhold any federal income taxes from payments to independent contractors. The only time you would withhold any federal taxes would be when you have 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. If the recipient must pay sales tax, and you pay these taxes in addition to these charges to the recipient, report the total on the 1099-NEC. 

What About Corporations?

Normally, you would not file a 1099-NEC when making payments to C Corps or S Corps. However, there are exceptions.

If the independent contractor’s W-9 indicates that the entity is an LLC and is taxed as a sole proprietorship, you would file a 1099-NEC for this recipient.

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.

Fishing Activities Have Special Rules

If your business involves purchasing fish for resale, you must report all payments made in cash over $600 in a year to a person or entity engaged in catching fish. The IRS requires you to keep records for the dates and amounts of each cash payment, but you only need to 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 and traveler's checks. Checks written on your personal or business checking account are not considered as cash payments.

Other Items That Should be Reported on 1099-NEC

These are examples of a few items that should also get 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 – If you paid for any parts and materials that the independent contractor needed to perform their services, these payments should be included in Box 1 along with the payment for services provided.
  • 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.

Important Things 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.

If you're used to filing Form 1099-MISC in past years to report non-employee compensation, then starting for tax year 2020, you’ll have to file another form, a 1099-NEC. You may still have to file a 1099-MISC for such items as rent payments, royalties or prizes, but 1099-NEC will be used exclusively for non-employee compensation.