1099s, Contractors and Employees

I am not a lawyer. Always ask a lawyer / tax advisor about your specific situation. But in general, The IRS has information on paying people for businesses expenses here -

IRS Publication for Small Businesses

To summarize, you have two choices for people you pay money to. Either they are an employee (someone who works regular hours long term) or a contractor (someone who does occasional jobs on non-set hours). You need to determine into which category a given worker falls. But anyone you pay money to is going to fall into one category or another.

If you have an employee, you are responsible for paying the social security and withholding tax out of their paycheck, and reporting this regularly to the IRS. Employee payments are logged on W2 forms. There are ALL sorts of rules and regulations about proper treatment of employees. There are ALL sorts of laws that kick in as soon as you have one employee, as far as medical benefits, social security benefits, you name it. Make sure you study those issues thoroughly.

Contractors, on the other hand, are sort of 'random task' people who you just pay directly to do something for you. You give them cash straight out, without holding anything back. If they charge you $200 to mow your lawn, you give them that $200. They are responsible for paying the taxes and such out of that money. At the end of the year, you send 1099 forms to your contractors, with how much you paid them over the year.

If you start using contractors (creating 1099s) or hiring employees (creating W2s), you have to apply for an Employer Identification Number (EIN) which is like a social security number for businesses. This is free, and can be done online.

If you just have people doing occasional work for you, so that they are a 'contractor', be sure to keep track of those payments very carefully. I checked in early 2005. At that time, if the payments you make to a person in a single year totals $600 or more, you now must create a 1099-MISC for them. You must have that submitted - both to the person and a copy sent to the IRS - by January 31st. The IRS then uses this document to make sure that the person who got the money properly claims it on their tax form.

Creating that 1099-MISC form is really pretty easy. Yes it needs to be done on "special red paper" but you can buy that at just about any Staples. You can send it through your laser printer or typewriter. Of course, this is something that your tax advisor can do for you, too, for very little money. My CPA charged me $25 each to do the 2 I had in 2004. Also, many software packages can generate those forms as well.

Of course I highly recommend that you check with EVERY person you sent any payments to, and verify the final, total amount you will be claiming. That way your records match their records exactly. You want to make sure your finances are 100% in order, just in case an audit occurs.

Taxes and your Home Business
Working from Home