Why is this Topic Important to Financial Professionals? Many small business owners are faced with issues surrounding Form 1099 and how the rules apply to their businesses. New regulations passed as part of Health Care Reform will change the past Form 1099 standard, requiring its applicability to many more situations and persons.
What are some distinctions of the employees versus independent contractors?
An independent contractor, in general, has a majority of control over the details of his job function and only the end result is dictated by the company or individual who hires. This is what is commonly known as “the degree of behavioral control.” Another category used by the IRS and the courts to determine the status of an individual as either an employee or independent contractor is “financial control”. Financial control involves examining the financial relationship between the parties such as reimbursement, and/or if any materials or space has been provided to accomplish the job. Other relationship factors such as having a contract or agreement between the parties, as well as the terms of any contract, must also be examined in determining the employment status of the individual.
One of the issues that is often overlooked in the area of an employee relationship instead of an independent contractor relationship is that employees have X number of hours to dedicate to employment each week, whether that number is 40, 50, or anything else that an employment agreement might state. Independent contracts are often not required to expend a set number of hours to accomplish a task, but instead enough hours to accomplish the task.
Another relevant issue to be considered in determining which of the two employment relations exist is that of termination. An “At-Will” employee can normally be terminated and generally has no cause for a breach of contract and cannot sue for damages. An independent contractor cannot usually be terminated without a breach of contract.
Taxation of the two dissimilar positions is significantly different. Independent contractors essentially work for themselves, and the business that pays them is, in effect, a client. Generally, and independent contractor will file a tax return as a sole proprietor or closely held corporation, such as a Subchapter S Corporation. An employee is subject to federal income tax withholding and the employer is subject to payroll taxes, included in the general W-2 process.
Independent contractors, like other businesses, recognize revenue and expenses. The independent contractor usually receives a Form 1099 from the source that pays him. The Code and Regulations state that when a trade or business pays an individual for certain “services” over $600 that a Form 1099 is required to be filed with the Secretary of the Treasury. And just as other businesses realize “legislative graces of Congress,” such as Section 162 deductions, the sole proprietor too may have expenses that generally qualify as trade or business expenses.
New 1099 Filing Requirements
The subject is further complicated by the new 1099 reporting requirements that will take effect in 2012. All business transactions resulting in payments of over $600 will be subject to Form 1099 issuing requirements. Neil deMause, a contributing writer for a CNN, has stated, the new rules could create significant changes to taxation of independent contractors. DeMause notes that while some independent contractors, “typically write off stacks of business expenses; having to issue tax paperwork documenting each of them could cut down on fraudulent deductions.”
The new reporting burden is likened, by some, as carrying around a book of Form 1099s and issuing them with every purchase a business makes, that is if the amount is, in total, over $600.
For a detailed analysis regarding independent contractors, see Tax Facts Q 814. How are business expenses reported for income tax purposes?
Tomorrow’s blogticle will address independent contractors’ tax and reporting issues.
We invite your questions and comments by posting them below, or by calling the Panel of Experts.
Internal Revenue Code Section (IRC) 6041, Treasury Regulations (TR) 1.6041-1(a)(1)(i), TR 1.6041-1(a)(2).
Neil Demuse. “Health Care Law’s Massive, Hidden Tax Change”. CNN Money, Small Business. May 5,2010. http://money.cnn.com/2010/05/05/smallbusiness/1099_health_care_tax_ change/index.htm?postversion=2010050523. Last accessed 8/18/2010.