IRS Issues Tax Tip for Businesses On Nonemployee Compensation

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Posted on July 29, 2022 |

The Internal Revenue Service (IRS) recently issued a Tax Tip reminding businesses of their obligations with regard to nonemployee compensation. As the IRS explains, while businesses generally are not responsible for withholding and remitting employment taxes when paying independent contractors, “business taxpayers who pay nonemployee compensation of $600 or more must report these payments to the IRS.”

In addition, businesses have an obligation to make a backup withholding with regard to nonemployee compensation in some cases. As a result, businesses that pay independent contractors need to take a proactive approach to ensure tax law compliance, and those that have failed to meet their obligations will want to evaluate their options before they face IRS scrutiny.

Understanding the Reporting Requirement for Nonemployee Compensation (and the Risks of Noncompliance)

Under the Internal Revenue Code, businesses that pay independent contractors $600 or more during any tax year must report these payments to the IRS using Form 1099-NEC, Nonemployee Compensation. This is a fairly straightforward filing, and, as noted above, it does not trigger a payment obligation in most cases.

However, there are some important considerations that businesses that pay independent contractors need to keep in mind. For example:

1. The IRS Decides Who Qualifies as an Independent Contractor

While businesses can label workers and service providers as independent contractors, this doesn’t necessarily mean that the IRS will agree. The IRS has established a test for determining whether an individual is truly a “nonemployee,” and it makes its own determinations during audits and investigations. To mitigate their risk of misclassification, businesses should apply this same test; and when in doubt, they should seek advice from their outside tax counsel.

2. Businesses Must Make a Backup Withholding In Some Cases

Even when businesses properly classify independent contractors as nonemployees, they must still withhold anticipated taxes in some cases. This is referred to as a “backup withholding.” As the IRS explains in its Tax Tip, “Nonemployee compensation . . . is subject to backup withholding if a payee has not provided a Taxpayer Identification Number to the payer or the IRS notifies the payer that the payee provided a TIN that does not match their name in IRS records. . . . The current backup withholding tax rate is 24%.”

3. Noncompliance Can Lead to a Comprehensive IRS Audit or Investigation

Employment tax compliance has been a priority enforcement area for the IRS in recent years. The IRS is also placing increased emphasis on self-employment and gig economy tax compliance through its Small Business/Self-Employed Division. As a result, businesses that fail to comply with the Internal Revenue Code’s nonemployee compensation rules are at high risk of facing IRS scrutiny, and they can face substantial penalties in the event of an audit or investigation.

Questions or Concerns? Request a Consultation with Kevin E. Thorn, Managing Partner of Thorn Law Group

If you have questions or concerns about your New Jersey business’s compliance with the Internal Revenue Code’s nonemployee compensation rules, we invite you to arrange a confidential consultation at Thorn Law Group. To schedule an appointment with Managing Partner Kevin E. Thorn, please call 201-842-7696, email or contact us confidentially online today.

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