[Updated 4/5/22]

Tax issues can be confusing. Recent tax laws regarding payments to independent contractors may add to the confusion. Knowing when to issue a 1099 to independent contractors is crucial for every business.  

In most cases, businesses must report to the IRS annual payments made to any single vendor totaling $600 or more. Payments include those to individuals, LLCs, or partnerships. Generally, a business owner does not file 1099 forms for payments to S or C-Corporations. Businesses that do not comply with tax laws can face severe penalties, interest, and additional taxes.  

Do you have questions about the 1099 forms and reporting requirements? Talk to our Maryland business taxation lawyer. Steve can help you avoid tax-related errors that could turn into costly headaches for you and your company.  

What Is the General Rule for Issuing a 1099-NEC to Independent Contractors? 

Many businesses use independent contractors to perform services. Outsourcing is an efficient and cost-effective tool. Many small businesses and large corporations use outsourcing. However, business owners must document and track payments to nonemployees. That includes individuals, vendors, subcontractors, and independent contractors. 

Covered payments may be made by bank transfer (ACH), cash, check, or credit cards. The types of payments reported include, but might not be limited to: 

• Income 

• Rents 

• Services 

• Awards 

• Prizes 

Beginning with the tax year 2020, payments to independent contractors must be reported using Form 1099-NEC. Previously, these payments were reported on Form 1099-MISC. Therefore, if you were required to send a 1099 form in the past, you are likely required to send a 1099-NEC form now. 

A small business or individual must issue Form 1099-NEC to report payments to an independent contractor. NEC stands for “Nonemployee Compensation.” The Internal Revenue Service lists four conditions for filing a 1099-NEC are: 

• You paid someone who is not an employee; 

• The payment was for services in the ordinary course of business or trade (payments for personal purposes are not included); 

• The payment was to an individual, estate, partnership, or in some cases, a corporation; AND, 

• The individual or company received $600 or more from you during the tax year.  

Each independent contractor receives a separate 1099-NEC for their payments during the tax year. As the payer, you must file Form 1096 (Annual Summary and Transmittal of U.S. Information Returns). The form is similar to a cover letter for the 1099-NECs you issued to independent contractors.  

If you will be paying an independent contractor for services, request a W-9 in advance of payment. The information on the W-9 is used to prepare a 1099-NEC. As a business owner, it is your responsibility to report payments to nonemployees.  

Filing electronically is an easy way to submit 1099 forms to the Internal Revenue Service. Companies may file 1099 forms electronically through the IRS Filing Information Returns Electronically (FIRE) system.  

Issuing a 1099-NEC for Payments Made Through PayPal and Other Third-Party Vendors Including Venmo and Wave 

There is an exception to issuing a 1099-NEC to an independent contractor. Generally, payments made through a third-party settlement organization (TPSO) do not need a 1099-NEC. Instead, the third-party payment service is required to file a Form 1099-K with the Internal Revenue Service.  

Examples of third-party payment organizations include, but are not limited to: 

• PayPal 

• Venmo  

• Wave 

• Lyft 

• Upwork 

• Uber 

• VRBO 

• eBay 

• Etsy 

Any platform that accepts payments from a party on behalf of another party is generally a TPSO. Likewise, companies that enable contact between independent contractors and clients may be considered a TPSO. In addition, many sites that allow self-employed individuals to sell items are also TPSOs. 

Significant changes to tax laws beginning in 2022 affect payments through PayPal and other third-party payment services. For example, before 2022, TPSOs only filed 1099-Ks for annual payments totaling more than $20,000 with 200 or more transactions. Therefore, an independent contractor could receive $50,000 in 100 transactions and the IRS would not receive notification of the payments from the third-party vendor. 

However, that changes with the tax year 2022. Beginning January 1, 2022, a TPSO must issue a 1099-K for any payment to a recipient of $600 or more. There will no longer be a minimum transaction requirement. Therefore, any independent contractor receiving $600 or more should receive a 1099-K. 

Exceptions for Payments Made Through the Friends and Family Option  

If you make payments to independent contractors through the Friends and Families option through PayPal or a similar service, you may need to issue a 1099-NEC to the independent contractor. Third-party payment services generally assume payments made through the Friends and Family option are not in payment for services. Therefore, they do not issue a Form 1099-K.  

Some companies pay their independent contractors through the Friends and Family option to avoid fees charged by PayPal and other services. However, businesses must be careful. If the payment meets the requirements for a 1099-NEC, the company may need to issue a 1099 even though they paid the independent contractor through a third-party vendor.  

What Is an Independent Contractor? 

Independent contractors are persons or entities who provide services for your company that are not employees of your company. Independent contractors work for numerous clients simultaneously. Generally, the IRS permits a person to be classified as an independent contractor if, among other requirements, the payer controls the result of the work but the independent contractor controls how to complete the work. 

Employers must classify employees and independent contractors correctly. The government requires employers to withhold employment tax from an employee’s wages. However, businesses are not required to withhold taxes from payments to independent contractors. Furthermore, independent contractors are not eligible for benefits available to employees.  

Seeking Help With 1099-NEC Questions From a Maryland Business Attorney 

Reporting payments to independent contractors is crucial. Failing to report required payments could result in penalties. If you have questions about 1099s, seek advice from an experienced business taxation lawyer. Asking questions and obtaining legal advice before filing tax forms is the best way to avoid tax audits, penalties, and other problems. 

Make sure that you comply with all federal and state tax laws. Contact Steve to schedule a consultation with our Maryland business taxation attorney. Attorney Stephen Thienel has decades of experience assisting clients throughout Virginia, Maryland, and the District of Columbia.