How 1099s Work
Businesses are not only required to meet their own tax obligations, but also to file 1099s so the IRS can tax their vendors and independent contractors too.
To understand the ins and outs of the notorious Form 1099, let's start at the source: the About Form 1099-MISC, Miscellaneous Income section on the Internal Revenue Service's website. It is a deceptively simple explanation, just 132 words long, that runs the entire gamut of circumstances under which companies are required to issue the form.
The first requirement kicks in when you exceed the exemption threshold for payments made to anyone outside your company, for essentially any reason whatsoever. Those thresholds range from $10 to $5,000, but the threshold for most 1099 filings is $600. It covers any of nine basic categories, ranging from "rents" to "any fishing boat proceeds." A single particularly broad category, "Other income payments," is the most common type of 1099 filing.
What's the point of the 1099?
‘Revenue’ is the IRS's middle name — literally. Since the agency's whole purpose is to collect taxes on income earned, the IRS needs a trustworthy reference to keep individual taxpayers honest when it comes to reporting their taxable income.
Form W-2, also called a "Wage and Tax Statement," was first used in 1943 as a means to withhold income tax at its source (from payroll wages.) But way back in 1918, the IRS had already started requiring employers to file 1099s to report salaries that exceeded $800.
Just as an employee's reported income on their tax return must match the amount reported on the employer-issued W-2, a vendor or independent contractor's reported income must align with the total of the individual amounts reported on the 1099s issued by each of their customers. (A vendor who received $30,000 each from five different customers in a year would receive five individual 1099s, totaling $150,000. So the IRS will expect to see at least $150,000 income reported on that vendor's income tax filing.)
In other words, the IRS relies on your company's 1099s as a compliance mechanism to make sure your vendors don't underreport their taxable income. And it's much easier for the IRS to enforce compliance via the proportionally smaller number of businesses that are required to issue 1099s (and W-2s) than the vastly larger number of individual taxpayers who receive them. The IRS hopes that simply knowing they have all those forms on file will keep individual taxpayers honest.
What about W-9s then?
By collecting a Form W-9 ("Request for Taxpayer Identification Number and Certification") from each of their vendors and independent contractors, companies should be able to gather most of the information they need to issue 1099 forms each January.
The IRS requires vendors to sign under penalty of perjury that the information they provide on the W-9 is accurate. So while it's not your fault if a vendor falsifies information on the W-9 they provide to you, it is your responsibility if you're missing that information all together when 1099s are due to the IRS in January. And it's much easier to get your vendors to provide their W-9s before you pay them than it is to chase them down months later when they've already been paid and therefore don't have much incentive to respond. So a best practice is to require each vendor to submit their completed and signed W-9 to you before you cut their first check.
Your responsibility doesn't end when you receive a W-9, either. You need to review what it actually says. It doesn't happen often, but some taxpayers are subject to mandatory backup withholdings. That creates some extra hoops for you to jump through each time you pay that vendor. In this instance, your company is required to withhold 24% of each payment you make to that vendor and send it directly to the IRS. (Part II of the W-9 will indicate this.) If you fail to properly withhold that amount, expect a nastygram from the IRS by the middle of the next year. That will come with its own set of headaches — not just a time suck, but also potential fees and penalties. Yikes!
W-9s are not to be confused with W-8s (which are confusing enough on their own)
Things get even more complicated if your business uses vendors and independent contractors who are not U.S. taxpayers. This category is very nuanced, with designations ranging from "foreign-domiciled business" to "non-resident aliens," along with other qualifiers.
Filers in this category can use any of five different versions of Form W-8, including W-8BEN-E, an eight-page document that stretches the limits of human comprehension. The "BEN" stands for "beneficial owner" and the "E" stands for "entity" (as opposed to an individual) — which is complicated enough. But the complexity reaches a whole new level if the entity claims to be a "disregarded entity," in which case they must then clarify whether they're "a hybrid making a treaty claim."
You get the idea. Collecting W-8 forms can be an enormous headache — and the IRS requires filers to send them to you, not the agency. And, as with W-9 filers, it becomes your responsibility to withhold taxes (at 30%) from any payment you make to W-8 filers that the IRS determines are delinquent or otherwise not in compliance.
That all sounds very onerous! Can't I just opt out somehow?
Sorry, not a chance. The IRS is very serious about enforcing compliance. They assess steep penalties for laziness and even steeper penalties for intentional fraud.
If your business failed to issue a Form 1099-NEC or Form 1099-MISC by the deadline for the 2022 tax year, for example, the penalty varied from $50 to $280 per form, depending on how long past the deadline you issued the form. And yes, "per form" means that the penalty is multiplied by the number of individual 1099 forms that you failed to file on time. So if you have 100 vendors and were assessed the maximum delinquency fine for each one simply because you were too busy to file them on time, that's a $28,000 penalty. (The news gets worse: Those penalty amounts will likely increase in the future.)
And if the IRS determines a business intentionally disregarded the requirement to provide a correct Form 1099-NEC or Form 1099-MISC for the 2022 tax year, that business will be subject to a minimum penalty of $570 per form or 10% of the income that should have been reported on the form, with no maximum.
Leave it to the professionals
If you're a business owner who makes payments of $600 or more to any vendor or independent contractor throughout the year — and these days, just about every business owner fits that description — you're in essence an IRS agent by proxy. It's a big responsibility, and one you shouldn't take lightly. Consult an accounting professional to be sure you've covered all the bases, and consider outsourcing all the tedious bits of ongoing compliance work to a qualified specialist.
