Tax Tips: When Should An Independent Publisher Use A 1099?
With tax season approaching, authors in the USA have to start worrying about the IRS and various forms they need to fill out – especially if they aren’t making enough money to warrant hiring an accountant to handle it all for them. One of the forms that independent publishers have to think about most is the 1099, and when it should or shouldn’t be used. That’s why we’ve asked John Endris, a guy who wrote the book on this sort of stuff, to give us all a quick primer.
Most independent publishers cannot afford to hire editors, cover artists, and assistants as a full or even part time employee. Therefore, they usually maintain a network of independent contractors (IC) to do these jobs for them. Like them, those workers are also small businesses, who have the same ability to make a profit or sustain a loss. Since they are also independent, they can even subcontract their job to another IC.
Regardless of who the worker (agent) is, or who hired them (principal), a 1099 form is used to record their income. However, there are only specific instances where you must file a 1099. So, the focus of this short post will be to explain the types of 1099 forms, what those are used for, when it is appropriate to send one out to someone on your team of ICs, and best practices for reporting business income.
Since 2011 I have hired several ICs, while also being one myself. In the beginning of my own one person business I had to learn about 1099s through trial and error, and then from the IRS. Even if you use a CPA for this task, the information provided here will help you skip an awkward phase of your business, and just focus on making money.
My guess is that most everyone in the indie author community already knows what a 1099 is. If you are just starting out and haven’t seen a 1099 before, it is the form the IC (agent) uses to report their business income from the person who hired them (principal) so they can claim business deductions. What some people in the indie community don’t know, is there are two different kinds of 1099 forms they need to know about:
- 1099-MISC: The IRS requires that if a business pays more than $600 to an IC during the tax year, a 1099-MISC must be issued. This kind of 1099 is ONLY used when you pay with a negotiable instrument (like a check or cash). The penalty for not doing so can be from $30-$100 per form. Plus $250 for intentionally disregarding filing protocol.
- 1099-K: US Code 6050W states “that third party network transactions (done by digital payment processors) must be reported on a 1099-K.” Therefore, the IRS does not allow a 1099-MISC Form to be sent for payments made electronically. However, Code 6050 also says the transaction processors “are only required to send out a 1099-K when the payment volume is $20,000 and there were 200 separate transactions” (US Code 6050W, Section e1&e2).
Clear as mud, which is why I deal with a 1099 problem every single year. On January 31st (the due date), at least one cover artist, or editor will complain that I did not issue a 1099 for them, or I will get a 1099-MISC when I shouldn’t. This, combined with a half dozen bullet point email responses, and annoying IRS calls I need to waste my time on, is the reason why I am writing this. As I am sure other independent publishers and freelancers also deal with this too.
First, nearly everyone in the indie community uses PayPal. Therefore, there is no way for the principal (payer) to know if their agent (IC/worker) has at least $20K and 200 separate electronic transactions. So, it is impossible to know if their agent (IC) will get a 1099-K.
Second, because there are penalties for failing to send out a 1099, but none for sending out an unnecessary one, tax preparers (also Internet chat forums) will often suggest the principal (person who hired the worker) send out a 1099-MISC to the agent (person they hired) “just to be safe.” This may seem innocuous, but for your IC it is annoying, and it may even make them not want to work with you anymore.
Why is this a problem? For the agent (worker), the principal sending a 1099-MISC for “protection” is a huge headache. If the agent is in high demand they probably meet the requirements to receive a 1099-K from the payment processor (PayPal). When they also get a 1099-MISC from their principal for the same income, it gets double reported to the IRS.
This then forces the agent to argue with the IRS about how they were only paid once and should not have to pay extra self-employment tax on the duplicate income. This type of conversation is guaranteed to be a tedious affair.
Here is what I wish I knew in the beginning of my business:
WHAT MAKES EVERYONE HAPPY
If you pay someone $600 or more during the year with a check or cash you must issue a 1099-MISC. If you pay them through an electronic intermediary like PayPal, you should not go through the trouble of issuing a 1099-MISC, and are not responsible for filing a 1099-K. If they have at least $20K and 200 separate transactions the digital payment processor will issue the 1099-K for you (if applicable).
What if the IC never receives a 1099-MISC because they never make more than $600 per year from each principal? Is that income not reported to the IRS via a 1099 form? What if the IC does not make over $20K and have 200 separate transactions and don’t get a 1099-K?
Could the IC get away with not reporting that income and paying self-employment taxes on it?
First, even if no 1099 forms are ever filed, the IRS will still know about the payment because there are strong regulations regarding anti-money laundering (AML). Those laws make it mandatory for every third-party payment service to report every transaction to the IRS. With this data, the IRS can easily use their mysterious auditing algorithms to find out who was paid what and when.
Second, the IRS will also know about the payment because the principal (hiring party) will certainly claim the agent’s (worker) payout as a business expense so they can reduce their taxable income. The agent may think that by not reporting (or under reporting) this income – but claiming a business deduction – they could show a loss for the year. This would then give them their sweet deductions while not having to pay any self-employment tax because they didn’t have any income, right? Wrong.
If their business does not make a profit for three of five years in operation, the IRS will classify their business activities as a hobby or what they call “an activity not engaged in for profit.” Therefore, if you choose to intentionally show a loss year after year, the IRS will erase all the business deductions you took in the previous years and make you pay your tax due (IRS Section 183). The take away is that you don’t need a 1099 to report your business income, but must do so.
The information provide here in this short commentary is just tax information, not tax advice. It does not replace the guidance of your tax professional, and is merely meant to enhance it. It will also help you keep your business safe by reducing the risk of an expensive audit. Better yet, it will allow you meet professional expectations.
With the ease of electronic payments, it is often unnecessary to go through the process of submitting a 1099-MISC. So, like most indies I use electronic payments as much as possible. However, there are some situations where you will need to issue a 1099-MISC (often for professional services, like attorneys).
If you are interested in learning exactly how to file a 1099 MISC, the changes to the 2018 small business deductions, and a few smart ways to set up your one person business, then check out my book “The Solopreneur: Your Guide To Running A One Person Business (For Authors, Artists, Freelancers, and Side Hustlers) I intentionally made it cost less than a cup of coffee.