By Paula Graham, Financial Strategist, EDGe Business Planning
If you had or have contractors working for your small business, you’re going to want to read this blog. I cover the new 1099-NEC versus the 1099-MISC, the new State of Virginia civil penalties for misclassifying contractors, and understanding the difference between a contractor and an employee.
New 1099-NEC versus the 1099-MISC
If you are in a trade or business, in the past, you’ve used a 1099-MISC form to report the amount you paid to other businesses or nonemployees during the year. Beginning with the current tax year 2020, businesses now need to use two different 1099 forms. At a high level, here’s when businesses use one form versus the other and the filing deadlines:
New Virginia Civil Penalty (§ 58.1-1900) for Misclassifying a Worker as a Contractor
Small businesses have always walked a fine line between contractor and employee classification. Crossing that line just got a lot more expensive. In the past, the State of Virginia has been clear that misclassifying a worker as a contractor is unlawful. However, per the Virginia Law website (LIS), starting on January 1st, 2021, the State is backing it up with monetary penalties. If you fail to properly classify an individual as an employee and you’re caught, the first time, the fine is $1,000 per misclassified person, the second time the fine is $2,500, and after that, the fine is $5,000 per misclassified person.
Is Your Contractor Actually an Employee?
If you are like most small business owners, the answer to this question is not always clear. The SCORE website provides seven instances where your contractor may be an employee by law.
You define the work hours: Generally, independent contractors do the job as they see fit. They set their own hours and work how and when they want. And they should be paid by the project -- never on an hourly basis.
You provide equipment or supplies: A hallmark of independent contractors is the fact they supply their own tools, equipment, and supplies. After all, contractors are, by definition, independent professionals. It makes sense they would have their own ladder, laptop, or lawnmower.
The relationship is indefinite: This is another red flag. The more permanent — or even long-term — the relationship, the more likely the worker is an employee. Remember, contractors, work on a temporary basis.
You don't receive invoices: The contractor should be treated as a vendor under accounts payable. You should receive invoices, and payment checks should be written to the business name — never the individual. Further, it helps your case if the worker has an Employer Identification Number (EIN) for tax purposes.
The worker only works for you: Independent contractors typically work with multiple clients. Contractor status is more apparent if the worker is servicing other customers at the same time he or she is handling your project.
There isn’t a contract: To protect your business, you should always have a signed agreement. Also, you should call it an “Independent Contractor Agreement” so there’s no question about the intent of the relationship. The agreement should specify how much you’re going to pay for the project and under what terms.
The worker performs core business services: Contractors should provide supplemental services but shouldn’t be an integral part of your business. For example, if you use a contractor to build a website for your construction company, that’s not a core business service. But if your business is designing websites — and your web designers are independent contractors — that could be a problem.
Chart (source: https://www.thebalancesmb.com/what-is-form-1099-misc-398362#form-1099-misc-vs-form-1099-nec)
Additional information can be found by consulting your tax accountant or at https://www.irs.gov/instructions/i1099msc#idm140364727413952.
For more information on the new civil penalty, view the LIS website https://law.lis.virginia.gov/vacode/title58.1/chapter19/section58.1-1901/
Contractor vs Employee - To learn more, go to the Score website https://www.score.org/resource/7-clues-your-independent-contractor-really-employee-under-law?gclid=CjwKCAiAt9z-BRBCEiwA_bWv-L-P4s_H79G_dIqgzpd8NmsfHwzU5CwMYVmyxmaPmvyvYkX8gYIXGxoCrAcQAvD_BwE