As a small business owner, you might pay an independent contractor. Non-employee compensation is the money you pay to an independent contractor that performs work for you. You report non-employee compensation in Box 7 of Form 1099-MISC.
It is important for you to understand how to pay and report non-employee compensation. You will treat non-employee compensation differently than employee wages. Use a 1099 software program to help you pay, record, and report non-employee compensation.
You must decide whether a worker is an employee or an independent contractor. In other words, you need to determine if the worker has non-employee status.
If you classify someone as an independent contractor, you have determined that an employer-employee relationship does not exist. To decide between employee or independent contractor status, you will want to pay attention to your relationship with the worker.
The Department of Labor (DOL) looks at six economic realities (factors) to determine the worker’s status. If workers can choose what work they do and how they perform tasks, they are non-employees.
Accurately classifying workers is important for filing and depositing taxes. Once you pay a worker as a non-employee, the worker must pay self-employment taxes.
Employees and independent contractors pay different tax rates. Employees share Federal Insurance Contribution Act (FICA) taxes with their employers. The employer and employee each pay 7.65% of the employee’s wages toward the tax.
But, independent contractors pay self-employment taxes, which means they pay both the employee and employer shares of FICA taxes. An independent contractor pays 15.3% of wages for FICA taxes.
If you classified a worker as a non-employee but the worker thinks they should actually be an employee, they can submit Form SS-8 to the IRS. This form requests that the IRS review the situation and make an official determination.
For employees, you report compensation to the IRS on Form W-2. But, you do not use Form W-2 to report non-employee compensation. Instead, you use Form 1099-MISC.
You will need to file Form 1099-MISC if you paid an independent contractor $600 or more. Have each independent contractor fill out Form W-9 before beginning work. Then, use Form W-9 to fill out Form 1099 during tax time.
Report non-employee compensation in Box 7 of Form 1099. Non-employee compensation includes fees, commissions, prizes, and awards you receive for services.
Send Form 1099 to the independent contractor and the IRS. Be sure to also send the IRS the summary form, Form 1096. Save a copy of each form you send for your records.
Examples of non-employee compensation
Sometimes, it’s not easy to tell who is an independent contractor. Here are three examples to help you make that decision.
Let’s say you own a flower shop. You make deliveries with a company van, but one day the van breaks down. You pay an independent mechanic (who does not work for an employer) $800 to fix the van. You paid the mechanic with non-employee compensation.
You should send the mechanic Form 1099. In the non-employee compensation box, Box 7, you will write $800. When you pay the mechanic, you do not withhold federal income tax, Social Security tax, or Medicare tax.
Still the owner of the flower shop, you also own a car that is your personal vehicle. You do not use your personal car for business operations. Your car also needs to be fixed, so you pay the same mechanic $600 to repair it.
Because the mechanic is fixing your personal car (not a business vehicle), you do not need to give him Form 1099.
Now let’s say you hire a freelancer to run your company’s website. You paid her $2,500 throughout the year to run the website. As a freelancer, she is not your employee. Instead, she is an independent contractor. You paid her $2,500 in non-employee wages. Again, you will not withhold taxes from her paycheck, but you will send her Form 1099.
Key points on non-employee compensation:
Workers who receive non-employee compensation are independent contractors, not your employees.
- The independent contractors must do work for your business for payment to be non-employee compensation.
- You must give Form 1099-MISC to the independent contractors you pay.
- You do not withhold taxes from non-employee compensation.
This article was updated from its original publication date (7/15/2013).