Tired of Filing 1099’s? Here Are Some Solutions
One of the most tedious and cumbersome tasks that many small business owners undergo in the new year is filing Forms 1099-MISC and Forms 1099-NEC. These forms are commonly required to report rent paid to landlords and compensation paid to independent contractors for the previous year. As a general rule, payments of $600 or more in a tax year by a business owner, for either of these reasons, require the payer to file a Form 1099 with the IRS and also distribute a copy of the form to the payee. This allows the IRS to match the deduction you are taking on your taxes to the income that the other person or business receiving the funds is required to report. But as with most general rules, there are exceptions—and I live for those exceptions as do many of my clients. For this reason, I have never been required to file 1099s for either of my own firms while maintaining my compliance with the law. Wouldn’t you like one less thing to do? If so, read on!
Solution #1- Use a Payroll Processor to Pay Your Independent Contractors
Many payroll processors that handle your employee payroll will also handle facilitating your payments to independent contractors via direct deposit, as well as filing the required 1099s at the end of the year. Some common examples of payroll processors that offer this service are ADP, QuickBooks Payroll, and Gusto. What is great about this option is that you can track every payment made to your contractors for that year and even integrate those payments to download into your accounting software automatically, which can be a huge time saver and increase the accuracy of your books. One of the disadvantages of this solution is that it can be a costly option depending on the provider.
Solution #2- Use a Third-Party App Such as PayPal, Cash App, or Venmo
For several years, PayPal was my favorite option for payment via third-party app to recommend to clients because it relieved business owners of the obligation to file 1099s and almost everyone has a PayPal account. However, every year more apps are gaining popularity and are added to the list of third-party payment processors that provide 1099 reporting. For tax year 2022, payments facilitated by Cash App and Venmo will also relieve the payer of the obligation of filing a 1099. This is because those apps will now be required to issue the payee a Form 1099-K which totals up all the electronic payments that a business has received from that app on a single form. How efficient is that?! Just as an FYI, Zelle, another popular electronic payment method, is claiming an exemption from this 1099 reporting rule since it merely facilitates bank transfers, so the apps are a better choice than Zelle if you’re looking to avoid filing 1099s. Payment by direct ACH bank transfer does not relieve the payer of filing a 1099, and Zelle falls under this exemption from 1099-K reporting.
On the other side of things, if you are a business owner that receives payment via one or more of these apps, the Form 1099-K reporting threshold is now $600, so be prepared to receive more Forms 1099-K than you may have received under the old rules when the $20,000 threshold was in place.
Solution #3- Pay by Debit or Credit Card
My personal favorite option for paying contractors is by debit or credit card. With this option, I don’t have to ask for a W-9, and payments are handled efficiently with detailed data on the memo line of my bank or credit card statement that supports the payment I have made. This makes it very easy to classify these transactions quickly within my books, and it is also an efficient payment option that is essentially free to the payer and can even earn you travel points, cashback, or other perks that credit cards may offer. As with the third-party app, this option doesn’t require you to file a 1099 because the merchant processor the business uses to accept your card payment will issue the payee a Form 1099-K totaling up all the payments they received during that year.
Solution #4- Deal Solely with Contractors That Are Corporations or Third-Party Intermediaries Classified as Corporations
Another great option that will prevent you from having to file 1099s each year is to deal solely with corporate contractors. 1099s are not required to be issued to corporations due to their high administrative reporting burden. They generally keep a full set of books and there is typically a lot less intermingling of business and personal transactions than for partnerships and sole proprietorships.
There are two sub-options available for paying corporate contractors. You can use a third-party intermediary such as Upwork, Fiverr, or Guru to pay a variety of different contractors. These intermediaries provide a platform that connects business owners with freelancers in various industries (such as software design, marketing, etc.), and the intermediary takes care of issuing 1099s to those freelancers. Some advantages of using these corporate intermediaries is the broad marketplace that is available to connect workers and companies, not needing to request a Form W-9 for any of these freelancers, and not being required to issue 1099s. The disadvantage is that these intermediaries charge fees on both the freelancer and client side, and these fees can be quite expensive.
The other sub-option is to directly pay a small business corporation without using an intermediary. For this option to prevent the filing of Form 1099, you will need to have a W-9 from the payee in which the payee has indicated that it is a corporation. Exceptions to this rule are medical corporations and legal corporations. A payer is still required to issue 1099s to those corporations unless you qualify under one of the previous exceptions for the payment method that I mentioned earlier or any other exception that I haven’t covered in this article. Feel free to check out the instructions for Forms 1099 for your reading pleasure if you’d like to find out more exceptions that apply!
The Worst Ways to Pay a Contractor…
By far, the worst way to pay a contractor is cash. Here’s why—it is very difficult to prove that the cash was paid and to whom. If an IRS audit arises, you cannot fully prove that the money you took out the ATM, pulled from the cash drawer, or withdrew from the bank was given to another person and not spent at the casino or for some other personal purpose. Paying via cash can result in some very unfortunate lost deductions, and this is compounded when the taxpayer doesn’t file a 1099 with the IRS and provide it to the contractor by the due date.
In my view, the second-worst way to pay a contractor is via check. I feel that we’ve evolved far past checks in 2022. Checks are still legal, of course, and many businesses will still accept them (though I generally do not unless there are some very special circumstances). However there are several problems that arise with paying via check: 1) checks can be returned for various reasons resulting in fees for the recipient and inconvenience for both parties 2) the recipient may hold on to the check for several months before depositing it—thereby causing reconciliation issues with the payer’s books 3) even checks deposited right away can take several days to clear, potentially causing delays to projects or scheduled work 4) payment by check requires the payer to request a Form W-9 from all the various contractors that they pay (and these can be very tough to get—especially after the vendor has already been paid) and 5) they require the payer to file 1099s. Those are valuable minutes and hours of our lives that we can’t get back.
But What About the Fees?
Many readers will argue that payroll processors, apps, and credit cards charge fees, and they are absolutely correct. But there are also costs associated with filing 1099s (software costs, a paid preparer’s time if you choose to use one, and your valuable time that could be spent doing something else other than chasing down Forms W-9 and filing 1099s at the end of the year). There are also fines for failing to file 1099s when required, fines for 1099s issued past the deadline, and worst of all the potential for disallowed deductions that can’t be proved, which translates into assessed tax, penalties, and interest. The costs of payroll processors, apps, and credit cards are simply necessary costs of doing business. These costs are directly connected with what it takes for your business to operate—payments in and out. Shop around if you are concerned about the costs of a particular option, but ultimately, as business owners, we don’t want to be penny wise and pound foolish. Efficiency is almost always the way to go when given a choice!
I hope you have found this article valuable! While it is still early in the year, I hope that you are able to incorporate one or more of these ideas to relieve yourself of the burdensome obligation of filing 1099s. At the very least, maybe you can reduce the number of 1099s that you are required to file. If you have any questions about paying contractors or filing 1099s, feel free to contact me using the form below.