Most small business owners do not comply with 1099 filing requirements. This can get them into trouble in the event of an audit. The purpose of this article is to educate you on filing requirements and the potential penalties associated with not issuing 1099s when you are required to do so.
What Is a 1099?
A 1099 is a form that alerts the IRS that you paid someone $600 or more, and that person is not your employee. The purpose is to alert the IRS that a payment has been made. The goal of issuing 1099s is to increase the revenue base for the IRS, because independent contractors sometimes do not report income if they have not been issued a 1099 for it.
The IRS has been stepping up enforcement of 1099 rules in recent years. If you get audited, the IRS is guaranteed to look to see if you have been issuing your 1099s. If you haven’t been issuing 1099s, bad things can happen. More on that below. But, the bottom line is that you are strongly advised to issue 1099s to your independent contractors (although it is ultimately your decision as a small business owner – I cannot and do not force clients to issue 1099s.)
Who Needs to File a 1099?
You are required to issue a 1099 if you are engaged in a trade or business and you paid at least $600 in one of the following:
- Services performed by someone who is not your employee
- Prizes and awards
- Other income payments
- Medical and healthcare payments
- Payments to an attorney, or
- Any fishing boat proceeds
As you can see, the rules are complicated (fishing boat proceeds? Really?). But basically, as a small business owner, this is what you need to know. If you pay a contractor or an attorney more than $600, you need to issue a 1099. If you are renting office space, you should issue a 1099 to your landlord.
However, there is an important caveat – 1099s are not required to be issued to corporations. So if you have a contractor (or landlord) that has formed a corporation, you are not required to issue a 1099 to them, even if you pay the corporation more than $600.
A Word of Warning on Contractors:
The EDD loves to go after small businesses that are misclassifying employees as independent contractors. California also has a very wide interpretation of what constitutes an employee. For example, they recently concluded that Uber drivers are employees, even though Uber drivers literally get to decide what days they want to work, what hours they want to work, and how long they want to work.
So, if you’re paying a contractor a lot of money, there is a decent chance that the EDD could decide that he or she is an employee. The EDD can assess severe penalties if they determine that you are deliberately treating an employee as an independent contractor. So be careful! If you have questions about whether a person is an employee or an independent contractor, consult with a knowledgeable employment attorney.
Deadline for Issuing 1099s:
1099s should be in the hands of your independent contractors no later than February 1st. It’s bad form to drop a 1099 on an independent contractor after they may have already filed their taxes. So, try to get your 1099s issued as soon as possible.
However, the deadline for sending a copy of your 1099s to the IRS is February 28th.
Penalty for Not Issuing a 1099:
If you fail to issue a 1099, the IRS has a variety of enforcement options, including, but not limited to, the following:
- The IRS can attempt to disallow the deduction that you should have issued the 1099 for.
- They can assess a penalty of $260 per 1099 that wasn’t issued.
- If they determine that you are willfully and intentionally disregarding the law, they can increase the penalty to $520 per 1099 that should have been issued but wasn’t.
Issuing your 1099s is a good business practice and can work to your favor in an audit. It establishes that you are making a good faith effort to comply with the law, and may generate some goodwill with an IRS auditor. This could be important if some of your other deductions aren’t properly documented. So, I strongly recommend that you issue 1099s. If you need help with filing 1099s, contact me and I can assist you.