New IRS Rules for Reporting Non-Employee Compensation

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McGlinchey Stafford

On July 6, 2020, the IRS issued Tax Tip 2020-80 to remind business taxpayers that, commencing with payments made in 2020, they must report any payments of over $600 per year for services by non-employees on Form 1099-NEC (for Non-Employee Compensation), a form last used by the IRS in 1982. Box 7 of the pre-2020 Form 1099-MISC was used in the intervening years to report these types of payments, but the resurrection of the Form 1099-NEC indicates that the IRS may be focusing on individuals who likely owe self-employment taxes on the income. The payments that must be reported only include payments made in the course of a taxpayer’s trade or business, but do include amounts attributable to parts and materials incidental to the provision of the services, as well as state and local sales taxes that are imposed on the service provider but which the service recipient pays to the service provider. The instructions provide that non-profit organizations and state, local, and federal agencies are all considered businesses that are subject to the Form 1099-NEC reporting requirements.

As is customary for Form 1099 reporting, payments to corporations (which includes limited liability companies that are taxed as S or C corporations) are exempt from Form 1099-NEC reporting; however, the instructions explicitly require cash payments to purchase seafood for resale and payments for attorneys’ fees to be reported on the Form 1099-NEC even if the seafood vendor or attorney is a corporation. With respect to payments to attorneys or law firms, only the portion of the payment that is for the attorneys’ fees is reported on Form 1099-NEC; gross proceeds paid to attorneys continue to be reportable on Line 10 of the Form 1099-MISC (even though that means that the attorneys’ fees are potentially reported twice). Similarly, payments made with a credit card or payment card and payments in the nature of third-party network transactions must be reported on Form 1099-K by the payment settlement entity, and are not subject to reporting on Form 1099-NEC.

The instructions to the new form include reminders of the types of payments that must be reported in Box 1. Directors’ fees, both made while the director is actively serving and those made after retirement, must be reported here. Also, if a business makes a payment on behalf of another person, who is the source of the funds, the payer is responsible for filing Form 1099-NEC with respect to that payment if the business performs management or oversight functions in connection with the payment or has a significant economic interest in the payment (such as a bank that is overseeing vendor payments on behalf of a borrower). Professional service fees, such as fees to accountants, architects, contractors, engineers, entertainers, and expert witnesses are included, as are fees paid by one professional to another, such as fee-splitting or referral fees. This includes the value of bartered services such as painting a house in exchange for legal services, but only if these services were exchanged in the course of their trades or businesses. Commissions paid to non-employee salespersons that are subject to repayment but which were not repaid during the calendar year are also covered. Taxable fringe benefits for non-employees as well as deferred compensation that is included in income for failure to comply with IRS Section 409A and golden parachute payments are all reportable on Form 1099-NEC, as are gross oil and gas payments for a working interest.

Non-employee compensation may be subject to backup withholding if a payee has not provided a taxpayer identification number (which includes a Social Security number, an employer identification number, and an individual taxpayer identification number) to the payer, or the IRS notifies the payer that the taxpayer identification number provided was incorrect.

The final version of the new Form 1099-NEC was released on December 6, 2019. Forms 1099-NEC must be filed with the IRS by January 31 following the reporting year (although the 2020 Form 1099-NEC is due on February 1, 2021 because January 31 falls on a weekend). This reflects the accelerated timing of employee and non-employee compensation required as a result of the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act), enacted on December 15, 2015, by a month. Forms 1099-MISC do not have to be filed until a month later.

Failure to file required Forms 1099-NEC subjects the taxpayer to penalties that can quickly prove significant. For taxpayers with gross receipts of $5,000,000 per annum or less, the penalty in 2020 is:

$50 per 1099, if you file within 30 days of due date with a maximum penalty of $194,000;

$110 per 1099, if you file more than 30 days after the due date but by August 1, with a maximum penalty of $556,500; and

$270 per 1099, if you file after August 1, with a maximum penalty of $1,113,000.

The maximum amounts are increased for larger businesses.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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