Reporting Independent Contractor Compensation

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With the calendar year quickly coming to a close, many business owners begin to review responsibilities for reporting taxes. One form small business owners frequently use is the 1099. There are twelve types of 1099 forms, but the one most commonly used is the 1099 MSC. Independent contractors, or freelancers, must use this to report income. With the changing economy, more employers have been turning to independent contractors rather than hiring full-time employees, and these businesses must report any services purchased in excess of $600. A business that employs an independent contractor must supply that contractor with a 1099 form at the end of the fiscal year, and the freelancer is required to use the 1099 form to report income and calculate any taxes due.

While regular employee wages are reported on W-2’s, only non-employee compensation is reported on the 1099-MSC. Misclassifying a worker as an independent contractor instead of a regular employee can cause costly problems with the IRS, so be careful to get the classification correct. The following are points to consider when determining whether a worker is an employee or independent contractor.

  • Freelancers should consider themselves as self-employed and they cannot get company benefits including health insurance, retirement, vacation time, or sick leave. The company doesn’t take federal, state, or local withholding tax from payment to the contractor.
  • The independent contractor normally has other clients and establishes his own work schedule and parameters, rather than being in the controlled setting of an employee.
  • The contractor uses his own materials, and his office is usually in another location.
  • The independent contractor has probably agreed to standards set out in a contract, and there is an understanding that the job may not be permanent.
  • The contractor pays his own expenses and is responsible for filing as self-employed, usually paying quarterly estimated tax returns.

The 1099 must be sent to the independent contractor no later than January 31 of the year after the service was rendered, and there are financial penalties for sending it late or failing to send. The IRS is able to track financial transactions and cross-reference the amount recorded. It is easy to blur the line between an employee and an independent contractor, and the IRS is cracking down, so it’s important to get it right!

View some of our other articles on 1099's: New Tax Law Affects Small Businesses and Update on 1099 Requirements.

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