Insights from Tax Year 2021 Form 1099-NEC Reporting

The tax season isn’t over yet, but one of the biggest organizational reporting challenges is behind us–   issuing and filing of Form 1099-NEC for payments companies made to nonemployees in exchange for their services.

As we look back on the flurry of activities that our organizations orchestrated to issue and file millions of Forms 1099-NEC to recipients and to the IRS, let’s take a moment to reflect on some key things.

Which form to Report – MISC, NEC or K?

Since nonemployee compensation payments can be reportable on one of three separate 1099 forms, it can be confusing to know which form to use. And, since some payments and payees are treated as exempt, businesses often don’t know whether to report a payment at all.

The most asked question that I receive when reporting Form 1099-NEC is related to payments that are made to attorneys and which form to report on.

Bottom line:

• Form 1099-MISC – Box 10 is used to report payments to attorneys for amounts related to any litigation matter.
• Form 1099-NEC – Box 1 is used to report payments to attorneys for amounts related to any business legal services such as reviewing employee or vendor contracts.
• Form 1099-K is used to report all payments made to attorneys via payment cards or via a third-party payment network.

Note that the requirements for these forms are different. Everything from who is required to issue the form, the thresholds for filing and the due dates for submitting to the IRS and states –all those details vary for each of these forms. Make sure to review the form instructions and related requirements to ensure you understand the differences and your company’s related obligations for reporting payments made to attorneys.

Reconciling backup withholding and reporting Form 945

Form 945 Annual Return of Withheld Federal Income (945) reports federal income taxes withheld from nonpayroll payments including pension and retirement income and gambling winnings, and federal backup withholding applied to payments of interest, dividends, rents, royalties, services, and other nonpayroll income.

Annually, the IRS requires a business to reconcile the Forms 1099 that reported backup withholding in Box 4 to the payments made to the IRS and report that on the 945. Often, this process entails businesses maintaining spreadsheets or other systems to aid in the reconciliation of so much data.

Some businesses don’t comply with the requirement and wait until an IRS penalty notice is issued for failure to deposit tax liabilities by the due date (plus penalties and interest).

With the increased focus on backup withholding compliance by the IRS, now is the time to minimize risk of penalty and cost associated with compliance. Modern technology can offer automated ways to track withholding liabilities, deliver payments to the IRS and states and retain all of the necessary details in the event of an audit.

FIRE went down on January 31

Although not a recommended best practice, many businesses wait until the last day of January to submit their annual Form 1099-NEC information to the IRS, leaving little time to work through any issues that may occur during that process. This year, that procrastination might have come back to “nibble them in the bum.”

The FIRE system went down for prolonged periods on the busiest filing day of the year. When it was up, it often performed intermittently at best. This delayed the ability to get forms filed timely and caused panic amongst a lot of businesses.

Hopefully, the IRS remembers that it was their system that failed when it comes time to assess penalties for late Forms 1099-NEC files for the 2021 season.

2021 Form 1099-NEC change: inclusion in the IRS CF/SF program

This is only the second year that businesses have been required to issue and file this form because nonemployee compensation used to be required to be reported in Box 7 of Form 1099-MISC. The IRS reintroduced Form 1099-NEC for filing nonemployee compensation and readjusted Form 1099-MISC reporting requirements beginning with returns filed for the 2020 season.

One of the primary issues that cropped up with the introduction of the new Form 1099-NEC, was the fact that the IRS did not include it in the Combined Federal State Filing (CF/SF) program for the 2020 season. The IRS shares Form 1099 information with the states via the CF/SF program – at least for the forms that are included in the program and the states that participate in it. This omission triggered 36 states plus the District of Columbia to enact direct reporting requirements for the form.

This year, the IRS sought to alleviate the burden of direct state filing by including the Form 1099-NEC in the CF/SF program. The late notification of the inclusion of the form in the program seemed to cause more confusion for states and businesses again.

Only four states published clear information that indicated that a filer could utilize the CF/SF to satisfy their 1099-NEC reporting obligations (when there is no state withholding also reported on the form). The remaining states and D.C. indicate the same requirements for 2021 returns as was required for 2020. State reporting of Form 1099-NEC information did not change much from tax year 2020 to 2021 outside of the inclusion of the form in the IRS CF/SF program.

Verifying CF/SF versus Direct State Reporting for Form 1099-NEC

State tax information reporting guidance is not always clear. One of the biggest reasons why is that it is often outdated. For 2021, Sovos contacted seven states that did not update the Form 1099-NEC requirements for 2021 season and received verbal confirmation that the form would be accepted through the CF/SF program (when there was no state withholding reported on the form). Without contacting each of those states separately, filers would have been forced to deliver information directly, which is more burdensome given the unique formats and requirements.

New tax portals created a bumpy filing season for some states and businesses

Many states are streamlining their tax portals and implementing new tax systems, and with that, new 1099 reporting requirements. Whenever new systems are introduced into a process, there are bound to be bumps in the road.

In Iowa, we saw the most notable impact. For a business to gain access to Iowa’s new portal to file their 1099 information, they needed to register and then wait for the state to mail an access code to the business address before they could log in and file 1099 information. Between outdated addresses and letters that were never received, filing 1099 information in Iowa was a headache for many businesses for the 2021 season.

Hopefully, we’ve cleared the highest hurdles that the 2021 season has thrown in front of us. Only time will tell as we head into the next phase – 1042-S reporting.