Companies that make payments to nonemployee service providers and vendors could face a challenging Form 1099 reporting season for 2020 due to the introduction of the new Form 1099-NEC.
To avoid a chaotic January 2021 filing experience, it’s important for filers to prepare in advance.
What Is the 1099-NEC?
The IRS has moved all nonemployee compensation income reporting from its traditional home in Box 7 of the Form 1099-MISC to the new 2020 Form 1099-NEC. Payments made in the course of a trade or business to US persons providing services will be reported, going forward, on the Form 1099-NEC. This single income type is the only payment information, outside of the corresponding federal and state tax withholding, that will be reported on the Form 1099-NEC.
All other traditional Form 1099-MISC income types, such as rent, other income, or royalties, will continue to be reported on the Form 1099-MISC. It’s important to review the updated 2020 Form 1099-MISC because the income-type boxes have been shuffled around to account for the nonemployee compensation box that was removed. Aside from the shuffling, there aren’t any major changes on the 2020 Form 1099-MISC.
Additionally, there are no changes in the rules for determining income that should be reported as nonemployee compensation versus other income types, such as other income or royalties, from prior years. This is simply a change in reporting mechanism.
Why Was This Change Made?
In recent years, the IRS discovered that significant fraud was occurring from individuals submitting tax returns with sizable refund requests using falsified Forms 1099-MISC.
These individuals were reporting small amounts of nonemployee compensation but large amounts of withholding. The tax returns would be submitted and processed prior to the March 31 IRS filing deadline for the Forms 1099, making it impossible for the IRS to match recipient statements with payer copies of the Forms 1099.
To avoid this, the IRS created a new policy. It no longer issued refund claims based on the Earned Income Tax Credit until after February 15, and it advanced the 1099-MISC IRS reporting deadline for nonemployee compensation to January 31.
However, these changes caused some issues for filers:
- Deadline confusion. The IRS filing deadline for Forms 1099-MISC reporting all other income types remained March 31, which created a dual-filing deadline for the Form 1099-MISC. This caused mass confusion among filers.
- Filing errors. A glitch in the IRS Filing Information Returns Electronically (FIRE) System would mark any e-file that was submitted after January 31 and included any Forms 1099-MISC reporting Box 7 income as a late file. It would then penalize the filer for every return in the file, not just the Box 7 reporting.
To avoid further chaos and confusion, the IRS resurrected the Form 1099-NEC for 2020, last used in 1982 before the original Form 1099-MISC was introduced.
2020 Filing Implications
Introduction of the Form 1099-NEC will most likely create complications for Form 1099 filers, and it will likely require additional work to prepare for the filing season. Here are some potential complications.
The IRS didn’t include the Form 1099-NEC in the Combined Federal-State Filing Program. This means that if you’re reporting recipients that reside in states that require submission of Form 1099-NEC information, you must submit a separate state filing in the format required by each jurisdiction.
As of early October 2020, only a handful of states have issued the requirement, but we expect many more to follow.
Composite Recipient Statements
Many companies have payees that receive nonemployee compensation along with other income reportable on the Form 1099-MISC. In prior years, these payees received a single recipient statement.
In January 2021, filers must send two separate statements:
- One for nonemployee compensation on the Form 1099-NEC
- One for other Form 1099 reportable income on the Form 1099-MISC
Under the composite statement rules listed in IRS Publication 1179, these statements aren’t allowed to be combined into a substitute recipient statement for 2020 reporting.
Multilevel Marketing Filers
Commonly, multilevel marketing filers (MLM) issue a significant number of Forms 1099-MISC reporting nonemployee compensation in addition to checking the box to indicate a “payer made direct sales of $5,000 or more of consumer products to a buyer for resale.”
Going forward, these recipients will receive a Form 1099-NEC to report that nonemployee compensation and a separate Form 1099-MISC with only this payer made direct sales box checked. There was hope that the IRS would include this check box on the Form 1099-NEC, as the two are often reported together, but that didn’t come to fruition.
Easing the Burden
Here are some steps that can help make these changes less of a challenge for your company and your payees.
Plan Your Communications
Communication is key in this transition year. Many of your historic Form 1099-MISC recipients won’t understand the change in Form 1099 or why they’re receiving it, so it’s important to communicate strategically with your payee population.
Form 1099 filers are required to provide a phone number on recipient statements for recipients to call if they have questions. To avoid crashing your call-in line and overwhelming current staff, send a communication along with your Form 1099-NEC recipient statements to explain the update. You may also want to budget additional time for your Form 1099 call center to satisfy inquisitive recipients.
Use the IRS TIN Matching System
Issuing two Forms 1099 to recipients who previously only received one puts a filer in double jeopardy for B Notices, which come with a $270 charge per form.
One of the best tools to help avoid B Notices is to use the IRS TIN matching system. Use the system for recipients you know you’ll have to report prior to the year-end rush. This can help provide you with adequate time to solicit updated name and TIN combinations before the January 31 filing deadline.
Test Systems and Review Your Reporting Population Early
Each fall the IRS releases updated e-filing specifications. This year the changes will be significant due to the update in nonemployee compensation reporting.
Make sure your organization or service provider is prepared and that you’re undergoing adequate testing to identify any gaps that could create issues in the data your systems will produce and the IRS FIRE System requirements.
Coordinate with Relevant Stakeholders
If you use a third-party system, check in with them to discuss how the information flow will be different this year. Is the reporting tool going to pull the necessary data from the correct sources? If you use templates to upload reporting information, how will those look different in 2020? Make sure you utilize your testing window to verify that prior-year reporting scenarios your company encountered will work with the current-year update.
If you use a homegrown system, work with the programmers to verify Publication 1220 Specification updates are included in the system and the output for the e-file and recipient statements are correct. It’s easiest to confirm this using the FIRE System testing window. Use actual prior-year reporting scenarios to verify that you’ve accounted for all of the situations you’ll encounter once production begins.
Determine Your Filing Season Strategy
It’s important to know what your recipient communications will look like. Many firms have a lengthy approval process for company communications, so make sure you’re prepared in advance.
If you have backup withholding obligations, you’ll likely need a reconciliation process to capture this withholding on both the Forms 1099-MISC and Form 1099-NEC and include a full accounting on the Form 945.
Key questions to consider during this process include:
- Will you provide recipients receiving both the Form 1099-NEC and Form 1099-MISC in a single mailing?
- Do you currently have that capability or will you need additional resources to accomplish that?
- Does your current service provider have the capability to accommodate your organization’s needs?
- Is it time to upgrade your system or provider to do so?
If you’re unsure how to proceed, a tax professional can help.
We’re Here to Help
If you have any questions about the Form 1099-NEC, contact your Moss Adams professional.