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Taxes can be an incredibly confusing and daunting element of self-employment to understand. Whether you are a business paying independent contractors or someone receiving payments for your labor, it is key to understand exactly what your tax obligations are from the beginning to set yourself up for success and minimize unfortunate tax surprises.
1099 NECs — the tax forms issued and received for non-employee compensation — are an essential part of your tax obligations, and understanding the ins and outs of these can be a bit tricky — so let’s simplify things and clarify your understanding of 1099 NECs, so you have a clear understanding.
When you pay or receive money in some way from work or services, you are not an employee; the IRS requires this to be tracked using specific tax forms that are filed with the IRS and included on income taxes. If you are on the receiving end of the money, you are required to pay taxes on that money, and if you are the one paying the money to someone else, you are required to issue a tax form to the recipient and the IRS so that that the recipient can pay their taxes.
There are two different categories of people who need to understand 1099 Taxes.
- You are being paid
- You are paying someone
Related: Time To Send Out 1099s: What To Know
If you were paid money as an independent contractor or for professional services
If you earned $400 or more in net income, the IRS requires you to report that income on your income tax return and pay income taxes. Because you are not an employee, you are self-employed and will claim this income on form Schedule C of your income taxes.
Schedule C provides space for you to list your income along with any deductions you can claim. Deductions will include any expenses related to your self-employment, materials or costs of doing that work or keeping your business up and running. This can include business startup costs, wholesale goods purchased for resale or operating expenses such as paying for a bookkeeper. These deductions are subtracted from your gross or total income earned and lower your taxable income – the amount of your income that is subject to taxes.
When a business or individual pays a non-employee, they are obligated to create and issue for 1099 NEC – which stands for non-employee compensation.
Understanding self-employment tax
There are two types of workers – employees and non-employees, often referred to as independent contractors. Employees are hired by a business to perform a specific job, given specific instructions on how and when to perform that job, and often receive training on how to perform those duties. Employees are put onto payroll, and when they receive a paycheck, the employer pays Medicare and Social Security taxes (along with several other benefits) in their payroll taxes, which are removed from the employee’s paycheck.
Independent contractors do not receive specific instructions, choose when and how to perform their duties, and are paid in full WITHOUT having social security and medicare taxes removed from their pay. Because an employer does not pay these taxes, the contractor is required to file and pay these taxes themselves. This tax is known as self-employment tax. The self-employment tax rate is 15.3% of your taxable income, covers Medicare and Social Security and is paid with your income tax return.
When the tax year ends, any individual or business that paid you $600 or more in non-employee compensation will send you a 1099 NEC tax form. You will then be required to enter this form (or have your tax professional enter this form) into your tax return on your Schedule C. Your deductions will then be entered, and your total taxable income will be subject to self-employed income tax, federal income tax and state income tax.
If you expect to owe $1000 or more in self-employed income in the NEXT tax year, you will also be required to pay estimated income taxes. Estimated income taxes take what you ESTIMATE will be owed next year and breaks it down into four payments, due quarterly throughout the next year — so this estimated balance is paid in advance instead of at tax time. Any overpaid amount will be refunded, but underpaying will result in a penalty, so it is best to overpay.
Understanding 1099 NECs for businesses who paid a non-employee
If you paid a non-employee $600 or more over the year, then the IRS will require you to create, issue and file a tax form to track those payments with the IRS so that the recipient has the tax form needed to pay their taxes on that income. You will be issuing form 1099 NEC for non-employee compensation.
To create this form, you must gather the worker’s information. This is done by having the worker complete form W9. It is best to provide the worker with a W9 before they perform the work to ensure that you have proper information on file for them, but if you have not yet done this, make sure to collect it before you create their 1099. The W9 will include their social security number, ITIN or EIN and their mailing address. This form and the information on the form will be kept confidential and is only intended for you/your business, the worker, and the IRS.
You will be required to create, issue and file form 1099 NEC by the end of January of the following year so that the worker can include the form in their income taxes.
1099s will be issued to individuals, partnerships, limited liability companies, or estates. The IRS gives the following examples of who should receive 1099s:
- Anyone who provided professional services, like accountants, engineers, or architects.
- Non-employee salespersons earning commissions.
- Independent contractors who get paid for services, goods, or travel or received benefits
- Professionals who received referral or fee-splitting fees.
- Non-employee entertainers for services related to your business.
- Certain people got golden parachute payments after a merger or acquisition.
Most payments to corporations are not included in 1099NEC except for the following:
The IRS states that the following payments made to corporations must generally be reported on Form 1099-MISC
- Cash payments for the purchase of fish for resale
- Medical and health care payments
- Substitute payments in lieu of dividends or tax-exempt interest
- Gross proceeds paid to an attorney
Understanding the ins and outs of 1099 NECs and your tax obligations as a business is complicated. Remember that it is always best to contact a tax professional who can evaluate and explain your own unique tax obligations as they pertain to your unique business needs and guide you on how to stay compliant and plan for successful tax preparation.