Most individuals receive a U.S. Internal Revenue Service (IRS) Form 1099 — Miscellaneous Income (1099) early each calendar year as part of their annual tax return documentation. They hold the document for their tax return preparation and then file it away without giving it another thought. If you are a small business owner, know that you too must send 1099s to nonemployees paid in the course of doing business. Members of the Virginia Society of Certified Public Accountants (VSCPA) warn 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.
Let’s start simple: If you are deducting a payment to a vendor, then the IRS wants to make sure that they are 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 nonincorporated 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. That seems pretty straightforward.
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, etc. — since 2012 contains two questions:
- Did you pay anyone more than $600 to whom you would be required to issue a Form 1099?
- Did you issue all required 1099s?
If you answer “yes” to the first question and “no” to the second, your risk of audit would be greatly increased. Business owners must be in full compliance to avoid fines.
To help insure that business owners comply with IRS regulations, CPAs advise that nonemployees 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, they will give you the correct name of the company/individual and the address for the purpose of issuing them payment. Second, they 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, such as PECO, Verizon, and so on. 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 they elect to be taxed. If they are taxed as a noncorporation (sole proprietorship/partnership/individual) then you are required to issue a 1099.
Business owners too often scramble at the end of the year to review and obtain missing W-9s. Vendors know why you are calling, and they 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 to not pay the new vendor until it complies with the W-9 request.
Beyond these basics, there are a lot of 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. But then 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, bills can easily top $600.)
- Attorneys, even if they are corporations, have to receive 1099s.
This can be confusing. It is an important topic to discuss with your CPA, and together you can devise a system that will capture the required information at the start of a relationship with a vendor and not in January when you are scrambling.