Businesses and independent contractors came across a new form in their tax documents in 2021. Last used in 1982, the Form 1099-NEC was brought back to life by the IRS to report nonemployee compensation separately from other types of miscellaneous income. The current Form 1099-NEC separates nonemployee compensation from other types of miscellaneous income that many taxpayers never encounter.
What Is Form 1099-NEC?
The IRS required that any compensation paid to nonemployees must be reported on Form 1099-NEC up until 1983. Then a box for nonemployee compensation was added to Form 1099-MISC instead, and the old Form 1099-NEC was retired.
Form 1099-NEC was once again mandated for reporting nonemployee compensation by the Protecting Americans From Tax Hikes Act of 2015, more commonly known as the PATH Act. This act also moved up the date for reporting nonemployee compensation to the IRS as well. Instead of filing this form with the IRS by February 28 as businesses did in the past, they now must do so by January 31 of each year.
Read More: How Does a 1099 Form Work?
What Is Nonemployee Compensation?
Business owners must report all wages they pay to employees during the tax year. Employers withhold income tax, Social Security tax and Medicare tax out of each check their employees receive. The employer then issues a W-2 Form to report their wages or salary and the taxes withheld.
But not all who perform services for a company are W-2 employees. Some are independent contractors. They're self-employed and not classified as employees, even if they do all their work for the same company.
Independent contractors have to remit their own income tax, Social Security tax and Medicare tax to the IRS on a quarterly basis because the company they perform work for is not withholding all this from their payments to them and sending the money to the IRS on their behalf.
The new Form 1099-NEC is solely for reporting nonemployee compensation.
Who Is a Nonemployee?
Businesses have the option of bringing in workers as needed rather than committing to a long-term employment commitment, but the IRS has strict rules when it comes to classifying workers as independent contractors. Ask yourself these questions to determine whether someone who does work for you is an employee or a contractor:
- Do they have the freedom to work whenever and wherever they want, or do they have to perform at certain hours at a location you determine?
- Do they control how the work gets done, with you focusing solely on the end result?
- Do they provide and use their own equipment to perform the work?
- Are they paid an agreed-upon one-time fee per job rather than a regular salary or an hourly wage?
The IRS breaks down your relationship with a nonemployee into three categories: behavioral control, financial control and relationship. An independent contractor agrees to perform a certain job for you.
You don't have an ongoing relationship. Your arrangement is finished when that job is completed unless you decide to embark on another project together. The contractor can perform that job for you wherever and whenever they please, perhaps subject to a final deadline.
You might hire Joe to set up a website for you, and Joe agrees that the job will be complete in one month's time. But you can't require that Joe work on that job at certain hours on certain days. Joe can build your website at 3 a.m. on Sunday morning if that's what works for him.
The contractor will tell you their fee for the service they're providing to you. You're free to accept that number, try to negotiate it or walk away. The opposite is the case with an employee. You tell an employee how much you're willing to pay them and they have the right to accept that and take the job, negotiate it or walk away.
You wouldn't provide a contractor with benefits such as health insurance, either, or sick pay or vacation time. These perks all fall under the "relationship" category and make the individual an employee.
Penalties for Misclassifying Workers
The distinction between contractors and employees is vitally important because misclassifying an employee as a contractor can get you into trouble with the IRS. You must pay half those Social Security and Medicare taxes for an employee. Not so with an independent contractor. They have to foot 100 percent of that tax bill, and you don't have to bother yourself with withholding anything from your payments to them. As a general rule, paying someone on a 1099-NEC basis is cheaper and easier.
Of course, the IRS is aware of this, so there are penalties if you pay an employee this way. The IRS can fine you up to $10,000, and even jail time is possible under some circumstances. At the very least, you'll most likely be charged with paying all those Medicare and Social Security taxes you avoided, so it's critical that you understand the rules and can demonstrate a reasonable basis for classifying the worker as a contractor before you issue these workers Form 1099-NEC.
The IRS stands by to help you determine which category a worker falls into so you don't run afoul of tax law. You can file Form SS-8 to ask the IRS to figure it out for you.
When Is 1099-NEC Required?
You must file a Form 1099-NEC to report the transaction if you pay a service provider $600 or more during the tax year. This is $600 total. You would have to file the form if you paid Joe $599 in January, then $599 in August for another job because these payments total $1,198 even though neither tops the $600 threshold.
And payments to individuals aren’t the only ones that merit a 1099-NEC. The form also applies to payments made to partnerships or estates. You would even have to report income paid to a corporation in some cases if it provides independent services to your business.
Deadlines to File Form 1099-NEC
The filing deadline for Form 1099-NEC is earlier than the one for reporting nonemployee compensation in the past. You must file the form with the IRS either on paper or electronically by January 31, 2022. Make sure it's postmarked by this date if you're mailing in the form. You have one extra day, until February 1, to provide a copy of the form to the contractor.
You can apply for a 30-day extension to file your 1099-NEC forms by submitting Form 8809, the Application for Extension of Time to File Information Returns. You must meet one of the following requirements to qualify:
- You suffered a catastrophic event in an area that was declared a federal disaster area.
- Your operations were affected by a fire, casualty or natural disaster.
- You or the person who files your forms experienced a serious illness, or your filer suffered a death or unexpected absence.
- This was the first year of your establishment.
- You did not receive the information you needed to file Form 1099-NEC on time.
You Might Still Use Form 1099-MISC
The return of Form 1099-NEC doesn’t do away with Form 1099-MISC. You’ll still complete Form 1099-MISC for certain payments. You just won't report contractor compensation on it any longer.
You must complete a 1099-MISC if your business paid anyone at least $10 in royalties or at least $600 in one of these categories:
- Prizes and awards
- Other income payments
- Cash from a notional principal contract to an individual, a partnership or an estate
- Any fishing boat proceeds
- Medical and health care payments
- Crop insurance proceeds
- Payments to an attorney
- Section 409A deferrals
- Nonqualified deferred compensation
Read More: Who Receives a Form 1099-Misc?
Filing Taxes as a Contractor
Independent contractors must file a tax return if their net earnings after subtracting business expenses are $400 or more for the tax year. This includes payments made to you from all your clients or customers. You're responsible for paying self-employment tax, the full 15.3 percent of your earnings to cover Social Security and Medicare because an employer isn't sharing this cost with you. This involves filing Schedule SE with your tax return.
But the good news is that you can claim business costs as deductions against your gross income by completing and filing Schedule C with your return. You can potentially claim your computer, the home office deduction and the cost of equipment and supplies. This will reduce the amount of income you pay taxes on each year.
- Accounting Today: IRS Revives Form 1099-NEC for Nonemployee Compensation
- IRS: 2021 Form 1099-NEC
- IRS: Instructions for Forms 1099-MISC and 1099-NEC (2020)
- IRS: Am I Required to File a Form 1099 or Other Information Return?
- IRS: Understanding Employee vs. Contractor Designation
- IRS: General Instructions for Certain Information Returns (2021)
- IRS: Form 8809 Application for Extension of Time To File Information Returns
- IRS: About Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding
- IRS: Businesses Have Feb. 1 Deadline to Provide Forms 1099-MISC and 1099-NEC to Recipients
- IRS: About Schedule SE (Form 1040), Self-Employment Tax
- IRS: Schedule C Profit or Loss From Business
- The CPA Journal: Employee Versus Independent Contractor
- IRS: Independent Contractor (Self-Employed) or Employee?
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.