One of the steps we recommend to clients who use independent contractors and who therefore face a heightened risk of a costly IRS payroll tax or benefits audit, is a quick review of some of the key things the IRS tells its agents to look at in determining whether a worker is really an employee.

The primary inquiries fall into three categories. Who has financial control of the job? Who can exercise control over how the worker performs the specific task? And how do the parties themselves view the relationship? When reviewing the checklist, keep in mind that the IRS will make its decision based on the whole picture, not just a single factor.

Workers are more likely to be classified as independent contractors if they:

• Make a significant investment in business property (a home computer is not significant);
• Pay their own business expenses;
• Receive a flat fee that is not based on an hourly or similar rate;
• Are not prohibited from doing work for other companies;
• Can pay subcontractors to get the job done;
• Are not performing services as an integral part of your regular business;
• Have a contract with an enforceable liquidated damages provision;
• Can make a profit;
• Can suffer a loss.

Workers are more likely to be classified as employees if they:

• Are given specific instructions and on-going training in how to get the work done;
• Cannot work for others;
• Have expenses paid by your company;
• Are paid with a salary or hourly wage;
• Do not have a significant investment in their trade or business;
• Are an integral part of your regular business;
• Receive direct reimbursement for all, or almost all, expenses;

Less important is:

• Whether or not the work is performed on the business’s premises;
• Whether the worker has flexibility in setting hours;
• Whether the relationship is temporary or short-term;
• Whether the work is full- or part-time;
• Whether the worker performs services for one or more businesses.

If you suspect from this list that there might be a problem, we would be happy to come in and do an audit of your hiring practices and suggest effective solutions if necessary.

All businesses make payments to vendors. But are you required to report these payments to the IRS? It depends on who you are making payments to and the amount being paid during the year.

Various types of Forms 1099 must be provided to certain type of payees by January 31, and to the IRS by February 28. Here’s a rundown of some of the more common payments that may require an information return.

• Payments of $600 or more to contractors or other services providers (other than corporations) must be reported to the recipient and to the IRS on Form 1099-MISC.
• Payments to attorneys for business-related services must be reported to the attorney and to the IRS. These payments must be reported on Form 1099-MISC regardless of the amount and regardless of whether the attorney is incorporated or not.
• Rents totaling more than $600 paid to an individual landlord, partnership, or estate (but not rents paid to a corporation) must be reported on Form 1099-MISC. (However, rents paid to a real estate agent are generally not required to be reported.)

These forms must be mailed to the recipient by January 31 and to the IRS by February 28.

Bear in mind that the penalties for failure to comply with these information-reporting requirements can be stiff. For example, you can be hit with a penalty as high as $100 for each return that is filed incorrectly or is not filed on time and deductions on tax returns may be disallowed in audits.

I think it is time for a little lesson on 1099′s for everyone.  Forgive my rant, but every year people start begging for their 1099′s in early January.  They say they “need their 1099 to file their taxes.”  This is simply untrue and tells me that many of them are probably cheating on their taxes.

A 1099-MISC form is issued to a person or unincorporated entity that is paid more than $600 in the calendar year.  If they pay you less than $600, the payor does not have to issue a 1099-MISC but that does not mean it is not income to the receiving party.  The purpose of the 1099 is to notify the IRS that this person should be claiming the income and paying taxes on it.  The IRS then matches this amount reported to the proper return and if it is not reported, the IRS sends out a lovely balance due notice.  Are these individuals that “have” to have a 1099 in order to do their taxes excluding the income from the ten vendors that paid them $500 each that were not required to send a 1099?

Independent contractors are self-employed are businesses whether they know it or not.  Just like any other business, they should keep a proper set of books and records to substantiate their income and expenses.  They are also eligible to deduct qualifying expenses against the income before paying taxes on it.

With electronic filing being done for most returns today, no statements like W2s have to be submitted to the IRS with the returns.  Even with paper filing, you only attach statements showing how much was withheld and remitted to the IRS.  1099s do not normally have withholding so they are not required and never have been required to be submitted to the IRS.

So when I hear someone asking for their 1099, I hear a business owner saying “I do not keep books and records.  I do not keep up with my business as a business.” and “I plan to only claim the income that is sent to the IRS.”  This is a recipe for pure trouble and is the reason the IRS scrutinizes self-employed filers so much.  The truth is that this one the highest concentration of tax cheating that exists in our tax system today.

Do yourself a favor.  If you are a business owner, require all potential 1099 vendors to complete the form W-9 from the IRS before they receive any payments from you.  If they are planning to cheat on their taxes, remember that they may not always be the best vendor for you.  Have a backup!