In an effort to help make filing taxes easier this year, we are breaking down the various IRS tax forms to help you know if you need them, and how to use them.
If you’re a freelancer or run a small business and use independent contractors, you’re probably familiar with the 1099-MISC form. This form is used to report income to freelancers, independent contractors, and other self-employed individuals who, as their own employer, are generally responsible for paying the employer’s and employee’s portion of taxes.
Thanks to its versatility, businesses and clients use the 1099-MISC form for many different kinds of transactions. It’s very useful, but also potentially confusing because of all the data it can hold.
Understanding the 1099-MISC Boxes
A 1099-MISC form is a catchall for all miscellaneous income that you provided or received. In an attempt to get all the necessary information for any situation, the IRS uses 18 boxes to collect data. If you’re a payer, you need to know which fields to fill out. And if you’re filling your tax return, you’ll want to know what your numbers mean.
1. Rents. If you rented office space, heavy machinery, soda machines, or live tigers from another company, total up the year’s payments and list them here.
2. Royalties. This includes all royalty payments, such as those from oil or mineral-producing properties.
3. Other income. This can include prizes (but not gambling winnings, as they have their own 1099 variant), damages from a lawsuit, or payments for participating in medical research.
4. Federal income tax withheld. This section is utilized when as a business owner you have to send a 1099 to an independent contractor who has refused to provide his or her W-9 and tax identification number. Just to be on the safe side, the Federal Government requires you withhold 28% of the money you pay to that person and send it to the IRS. In all other situations, it’s up to the independent contractor who receives the 1099 to figure out how to pay their taxes. See the Form 1099-MISC instructions for further explanation on what income you can withhold taxes on.
5. Fishing boat proceeds. Here you report the monetary value of the catch shares that the individual received over the year, plus any other payments made that were contingent on a minimum catch.
6. Medical and healthcare payments. If your business employed a physician to conduct yearly physicals or administer flu shots, you might have to send him or her a 1099-MISC. This would include any amount you paid for medications sold to you by the physician. For example, if the physician charged you $20 per flu shot and $200 for labor, you would also include the $20 per flu shot on this amount.
7. Nonemployee compensation. If any independent contractor did work for your business but wasn’t an employee, here is where you report what you paid that person. You aren’t required to send the contractor a 1099 unless you paid $600 or more during the year. As a contractor, or freelancer, it’s in this box that you’ll find the compensation you need to report to the IRS. Generally, these amounts are subject to self-employment tax and income tax. Golden parachute payments, taxable fringe benefits for employees, and referral fees also should be included here.
8. Substitute payments in lieu of dividends or interest. This situation is extremely uncommon and involves loaning out your dividend-paying securities. If you need to use this section, your broker should send you the details.
9. Payer made direct sales of $5,000 or more of consumer products to a buyer (recipient) for resale. This is just a checkbox. You aren’t required to report exactly how much you sold to a buyer, just that you made a sale. This box is useful for organizations such as Amway, since it sells items for resale outside of a traditional retail environment.
10. Crop insurance proceeds. If you received payouts from crop insurance, the amount should be input here.
11. and 12. Blank, for government use only.
13. Excess golden parachute payments. A golden parachute payment is one made to an employee (generally an executive) who is leaving a company and is contractually able to receive a large payment upon departure. Excess payments are those amounts above what the individual received on average over the past five years.
14. Gross proceeds paid to an attorney. Here you must input payments over $600 that went to an attorney for legal services.
15a. Section 409A deferrals. Use this box if you contributed to a section 409A retirement plan but weren’t an employee.
15b. Section 409A income. If you contributed to a section 409A plan but it didn’t meet specific guidelines, it can be counted as taxable income, and you must input the amount here.
16. State tax withheld. If any state tax was withheld, it may be listed here.
17. State/Payer’s state number. If state tax was withheld, enter the identification number of the company that withheld the tax here.
18. State income. This is the amount of money reported on the form that is subject to state tax.
When Does Your Business Need a 1099-MISC?
Generally, your business must file a 1099-MISC only if you paid someone $600 or more over the course of the year. If you received more than this amount, expect a 1099-MISC from the payer. A few exceptions include:
- Royalties. $10 minimum reporting threshold.
- Fishing boat proceeds. You must report any amount.
- Consumer goods. If you sold anyone any items for $5,000 or more in a market other than a permanent retail establishment (such as Amway or flea markets), you must report it.
- Tax withholding. If you’ve withheld taxes for someone because they were subject to backup withholding, you must report it no matter how little you paid them during the year.
Keep in mind that the IRS only requires these forms when companies pay vendors in the course of operating a business. When you pay the neighbor kid for babysitting, you don’t have to worry about reporting those payments.
Taxes Due From Business Income
Regular employees have half of their Social Security and Medicare tax paid for by their employer. When paid by contractors and freelancers (who naturally don’t have tax withheld by an employer), this tax is often called “self-employment tax” and is due in addition to regular income tax. To figure the amount of this tax, self-employed individuals need to file Schedule C (or Schedule C-EZ), which is the form used to tally business profits and expenses.
Transfer the revenue from box 7 of your 1099-MISC onto Schedule C and subtract your business expenses to determine whether you had a profit or a loss for the year. Then, transfer that income amount to Form 1040 (subtract a loss from any other income you report, add a profit). If you had a profit, complete Schedule SE to determine how much self-employment tax you owe and transfer that amount to your 1040 as well.
What’s the Difference Between Schedule C and Schedule C-EZ?
In general, Schedule C-EZ is intended for people who did some work on the side or had a very simple small business. You can’t use it if any of the following apply:
- You plan to take the home office deduction
- You spent more than $5,000 on the business in the past year
- You employ additional staff
- You expect a loss for the year (you spent more on the business than you made)
If you’re not sure if you’re eligible for a Schedule C-EZ, don’t risk it. The standard Schedule C won’t take much longer to complete, even if you have small-business expenses to deduct.
What Is Schedule SE?
If you have a profit after you complete either Schedule C or C-EZ, use Schedule SE to determine how much Social Security and Medicare tax you owe. You have to pay Social Security and Medicare tax on the first $106,800 of money that you earn – anything above that is subject to income tax only. If you didn’t make a profit, you don’t have to fill out this form.
In general, you pay 15.3% of your business profits in Social Security and Medicare taxes. Due to it’s complex nature, I highly recommend you use a tax program to fill out this form.
There are several cases in which you can report your 1099-MISC money directly on your 1040 without having to worry about whether you need to use Schedule C or Schedule C-EZ.
If your income was reported in box 3 of your 1099-MISC, it is generally not considered “earned income” and you do not need to pay self-employment tax on it. However, you do need to pay regular income tax on it. Report income in box 3 of your 1099-MISC plus these other types of income on your 1040:
- Prizes or Awards. This includes game show or sweepstakes winnings, but not something like an incentive-based contest you won at work.
- Jury Duty Pay. Jury duty pay is taxable as a write-in adjustment to income on your 1040. Label it “Jury Pay.”
- Canceled or Forgiven Debts. Your creditor is required to send you a 1099 with the forgiven or cancelled amount. You might receive a 1099-C for this.
- Barter Income. This counts even if cash didn’t trade hands. If you barter with someone who is a by-the-books type, he or she may send you a 1099-MISC for the value of the services or items they traded with you. Of course, this is your cue to send one for the value of the services or items you traded as well.
- Hobby Income. This is the little bit of money you might earn from a leisure activity – one you do without intending to make any money. Since you weren’t looking for income, it’s not considered self-employment. Still, you’re required to pay regular income tax on it. If you have expenses from your hobby, you can deduct them up to the amount of money you brought in if you itemize. After three profitable years of making money at a hobby, the IRS will consider it a small business and no longer a hobby.
- Gambling Winnings. You may not receive a 1099-MISC (you might get a W-2G), but either way, you should include gambling winnings on your 1040. If any income tax was withheld, as sometimes happens with large payouts, you’ll also account for this on your 1040. If you had winnings, you can deduct gambling losses, but only up to the amount you won.
You may encounter a confounding situation with one or more 1099-MISC forms you receive. Here are a few of the most common:
1. I received a 1099-MISC for income I wasn’t paid until the following year. What do I do?
If this happens to you, don’t worry. The IRS knows you are not the first person who’s been on the end of some last-minute accounting. As long as you “settle up” next year and accurately report the income on that year’s taxes, you will be fine. Hold onto documentation that supports when you took possession of the money, such as:
- Bank account records
- Postmarked envelopes
- PayPal records
- Invoices, paystubs, or other records of payments
2. I got a 1099-MISC for money that was paid to me, but I paid other people with that money. What do I do?
If the payment of that money has anything to do with your business, you can probably deduct it as a business expense on Schedule C.
For example, if you’re a general contractor in charge of building a home, and you paid money to subcontractors such as plumbers, electricians, or drywallers, you can claim the sum of what you paid as a business expense against the income you received on your 1099-MISC. Other examples of business expenses include postage, office supplies or equipment, communication, and travel expenses.
3. The only income I earned all year was reported to me on a 1099-MISC. How much do I owe in taxes?
If you didn’t pay estimated taxes and had no taxes withheld by an employer, you may owe a lot. You’ll owe 15.3% of your profit in Social Security and Medicare taxes right off the bat. Additionally, you’ll have to pay regular income tax, the amount of which will depend on your total income after taking deductions and credits. Plus, you might be penalized for not paying estimated taxes throughout the year (if your tax liability is more than $1,000). But fortunately, filing your taxes is quite simple.
Start by filling out a Schedule C or Schedule C-EZ – this is where you report 1099-MISC income and deduct related expenses. Then, fill out Schedule SE to determine your Social Security and Medicare tax liability. (Half of this amount is deductible when you determine how much regular income tax you owe.)
Last, report your profit from Schedule C (or C-EZ) on your 1040 to figure what you owe in regular income tax. If you know that you’ll only have 1099-MISC income this year, it’s best to pay estimated taxes during the year to avoid an underpayment penalty.
“Miscellaneous” is like a double-edged sword when it comes to a 1099 form. It’s an easy way to cover tax issues that don’t fall into conventional categories, but it can create confusion as well. If this is your first year owning a business and dealing with 1099s, it’s worth hiring a tax consultant to make sure you take advantage of all deductions available to you and you schedule the correct amount of estimated taxes for the following year.
Have you had any issues reporting income from a 1099-MISC?