This topic comes up often in conversation with my small business owners. Subcontractors want to be paid with no taxes being withheld, but that is not the law. Please contact me at 732-262-0061 to discuss your specific situation.
Small Business Owners Beware: Not Reporting Income Paid to Vendors Can Be Costly
Most individuals receive an Internal Revenue Service (IRS) Form 1099, Miscellaneous Income, early each calendar year as part of their annual tax return documentation. They normally hold the document for their tax return preparation and then file it away without thinking about it. Small business owners, too, must send 1099s to non-employees paid in the course of doing business. The New Jersey Society of Certified Public Accountants (NJCPA) warns that many small business owners do not understand the requirements for issuing 1099s, and they can receive hefty fines and costly IRS audits if not complied with properly.
For example: If you are deducting a payment to a vendor, then the IRS wants to make sure that it is picking it up as income. There is a dual requirement. The recipient of the payment is required to report any income—whether or not it meets the threshold for receiving a 1099—and the business is required to issue 1099s to any non-incorporated business or individual from whom it purchases more than $600 in goods or services during a calendar year. Failure to do so will result in a $100 penalty for each 1099 that is not issued as well as the potential loss of that deduction on the tax return.
Problems arise when business owners do not realize that the person/business they are paying is eligible to receive a 1099. Further, as part of IRS compliance, every business return— Schedule C, partnership, corporation, and so on— since 2012 contains two questions: (1) Did you pay anyone more than $600 to whom you would be required to issue a Form 1099? (2) Did you issue all required 1099s?
If you answer the first question yes and the second question no, the risk of audit would be greatly increased. Business owners must be in full compliance to avoid fines.
To help ensure that business owners comply with IRS regulations, CPAs advise that non-employees complete a Form W-9. Having each vendor who you are not 100-percent sure is a corporation complete a Form W-9 will provide you with certain valuable information. First, it will give you the correct name of the company/individual and the address for the purpose of issuing it payment. Second, it will sign them. If you use the W-9 as the basis of whether or not you issue a 1099 and use the information on the W-9 to issue the 1099, you cannot be penalized. The only business that you would not obtain a W-9 from would be a business whose name ends in “Corporation,” “Inc.,” or “PC.” Business owners can also exempt publicly traded companies. For all others, CPAs advise business owners to get a W-9. Many people think that an LLC is a corporation; it is not. The requirement to issue a 1099 for an LLC is based on how it elects to be taxed. If it is taxed as a non-corporation (sole proprietorship/partnership/individual) then you are required to issue a 1099.
Business owners often scramble at the end of the year to review and obtain missing W-9s. Vendors know why you are calling, and they probably do not call you back. They have no incentive to supply this information accurately or quickly. They will have incentive, though, if they are waiting for a check. CPAs advise business owners to obtain a W-9 as they add a new vendor and not pay the new vendor until it complies with the W-9 request.
There are many exceptions and other issues that may affect who gets a 1099. For instance, because of reporting requirements of third-party merchant services, anyone you pay by credit card is exempt from 1099s. There is a host of people and businesses that are often missed:
- Your landlord.
- Contractors who do repairs and maintenance for you. (Often clients know that they are eligible, but since the work was less than $600, they do not need the info. However, if called a few times during the year, the bills can easily top $600.)
- Attorneys, even if they are corporations, have to receive 1099s.