In a growing gig economy, it’s becoming increasingly common for companies to rely on freelancers, agencies, and independent contractors to complete vital roles across the business. But when handling independent contractor taxes, how much responsibility do you have as a company, and what’s left up to the contractor? Let’s break it down.
This is part of an extensive series of guides about compliance management.
Related content: Read our guide to reporting 1099.
Does my company have to withhold independent contractor taxes?
If you’re used to hiring employees, you’re probably familiar with the process of withholding taxes, where you keep back income taxes, social security, and Medicare taxes from your employee’s paychecks, as well as the need to pay unemployment tax on employee salaries. However, when you’re working with independent contractors it’s a whole different ball game, (and we have to say, the rules are a lot easier to follow.)
Freelancers, independent contractors, gig workers, and agencies don’t fall under the same category as employees, and so you don’t need to withhold taxes on what they earn.
Instead, the responsibility of paying self-employment taxes and income taxes on income falls squarely on the shoulders of the worker. For businesses, this is one of the benefits of using independent contractors – and as a result, they can cost 30% less than full-time employees.
Governments recognize that they lose significant revenues from gig worker relationships compared to the taxes they receive from full-time employees. This is one of the reasons why many states have legislated stricter workforce classification laws lately that make it harder for companies to define their workers as independent contractors. If ignored or misunderstood, there can be steep fines to contend with.
Which tax forms does my company need to submit for independent contractors?
Before you get too excited, zero withholding doesn’t mean zero responsibilities. Although your requirements are minimal, there are a few elements you need to be aware of.
Form 1099 submission for US-based independent contractor taxes
First, the good news. If you’re not planning on paying your independent contractor more than $600 for their services – you don’t legally have to provide or collect any documentation at all. That means if you’re hiring a graphic designer to create your business cards, and you’re paying them $599 for their trouble, you can sleep easy at night knowing you have nothing to report.
However, once you hit that $600 mark, or if you’re planning on forming a longer-term relationship with your independent contractors, you’ll be responsible for reporting your payments to the IRS. You do this for every independent contractor individually, using Form 1099-NEC, which as of 2020 has taken over from Form 1099-MiSC.
If your company is not paying your freelancers directly, but through a payment provider such as Bill.com, PayPal, or Venmo, or a freelancer marketplace like Fiver or Upwork, then you should be aware that up until 2022 you were not required to submit a 1099 form unless you paid more than 200 transactions per year per freelancers. But recent changes to the new legislation for payment providers (1099 K requirements) you are now required to submit a 1099 for every freelancer which you paid more than $600 per year. Your payment provider or freelance marketplace, might do it for you, but it’s your obligation to check.
In order to fill out Form 1099-NEC, you’ll need some information about your independent contractors. That’s why it’s important to get your freelancers and gig workers to fill out Form W-9, or if they’re foreign contractors – Form W-8 BEN. These forms are used to provide some basic details that can be used to complete the 1099-NEC each year. You can check out this guide for more information on how to fill your 1099 NEC tax form.
Make sure to submit the form either by physical mail or through the IRS’s electronic filing system no later than January 31st. You’ll also need to send the form to each independent contractor no later than January 31st of the following year so that they can submit their own tax forms. This date isn’t set in stone. For example, if January 31st falls on a holiday or weekend, the date for filing may move to the next business day.
Please note that these forms apply only to US-based companies. UK-based companies should follow the UK off-payroll working rules and IR35 guidelines.
Form 1099 submission for independent contractor paid through a third party
If your company is not paying your freelancers directly, but through a payment provider such as Bill.com, PayPal, or Venmo, or a freelancer marketplace like Fiver or Upwork, then you should be aware that up until 2022 you were not required to submit a 1099 form unless you paid more than 200 transactions per year per freelancers.
However, recent changes to the new legislation for payment providers (1099 K requirements) you are now required to submit a 1099 for every freelancer which you paid more than $600 per year. Your payment provider or freelance marketplace, might do it for you, but it’s your obligation to check.
Form 1042-S submission for non-US contractors
If you are working with non-US independent contractors who have submitted a W-8 tax ID form, you will need to submit Form 1042-S. This is how the US government keeps track of funds that are leaving the country. It is important to note that the IRS, unlike 1099 NEC, is not strict at all and many companies are not submitting this form.
However, as the workforce is becoming increasingly global and more funds are being redirected to non-US workers, it is expected that the IRS will change its policy regarding Form 1024-S late submission penalties in the near future.
Late submission penalties
Mark that date in your diary, because if you miss the deadline, you’ll be subject to a fine of between $50-270 per independent contractor, depending on how far past the deadline the form is submitted. These fines can rack up fast, and aren’t capped until you reach $556,500 in a single year. If the IRS suspects and proves that you intentionally ignored the need to submit, there is no maximum on the penalties that can be levied, and they will start at a minimum of $550 per form (or 10% of the income reported).
If you’re looking for a comparison between tax form 1099 vs W2, check out our article.
Which forms do I need to collect from my independent contractors?
The first step is to understand which tax authorities your independent contractors are paying taxes to. This will dictate which tax forms you will need to submit to your tax authority (The IRS for US-based companies).
Form W-9:
This form is for US citizens, and your contractors will use it to provide their Tax Identification Number (TIN) as well as let you know whether they are incorporated. For the IRS, this form acts as written proof and confirmation of your independent contractor’s business name and ID. Their signature on this form helps your business to sidestep any responsibility for the contractor’s tax requirements. In fact, once these forms are filled in, your organization carries no liability for independent contractor taxes whatsoever– even if the worker misrepresents their location or status.
W-8 BEN:
Form W-8BEN is the equivalent of a W-9, but for foreign contractors. Don’t forget – if your foreign contractors operate as a business, they will need Form W-8 BEN-E instead. If your workers are foreign contractors, you don’t need to fill out the 1099-NEC at all. You can simply keep the W8-BEN on record to support why independent contractor taxes were not withheld.
Don’t Forget!
Both the W-9 and W-8 are valid for three years, so make sure to set a reminder or alert to renew the forms if you are still working with this contractor once that period of time has passed.
Simplify your management of independent contractor taxes
Managing independent contractors can be even simpler than working with traditional payroll employees, as long as you have all of your ducks in a row. For businesses looking to reduce the January rush, here’s a checklist for success:
- Ensure you have a full list of all your independent contractors, organized by US vs non-US citizens/businesses.
- Create a process for offboarding independent contractors to ensure your records will always be up-to-date.
- Request that new contractors submit the correct Form W-9 or W-8 as part of onboarding, to ensure your information is ready for the next 1099-NEC filing date.
- Update contractor forms either annually, or at least every 3 years in line with when they expire.
- Keep W-8/W-9 documentation on file for four years, even when 1099-NEC forms are not required. This is in case the IRS has queries, or you’re faced with an audit.
See Additional Guides on Key Compliance Management Topics
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