What Virginia Businesses Need to Know About Nonemployee Compensation in 2022

With the gig economy bolstered by the COVID-19 pandemic and wages skyrocketing as businesses compete for qualified employees, many businesses are finding themselves increasingly reliant on independent contractors. While hiring employee contractors offers a variety of benefits—including tax benefits—businesses need to ensure that their “nonemployee” compensation practices are not putting them at risk for IRS penalties.

5 Key Facts about Nonemployee Compensation Tax Compliance in 2022

If your business relies on independent contractors, what do you need to know about nonemployee compensation tax compliance? Here are five key facts for Virginia businesses in 2022:

1. Payments to Independent Contractors Generally Do Not Count Toward Employment-Related Credits and Exemptions

As we recently discussed, the IRS is paying close attention to businesses that claimed the employee retention credit created under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. This credit was only available to businesses that paid “qualified wages” to employees. Payments to independent contractors are not qualified wages under the CARES Act. Thus, businesses that claimed the credit and that utilize independent contractors should ensure that they calculated the credit appropriately.

More broadly, payments to independent contractors generally do not count toward employment-related credits and exemptions. As a result, businesses that improperly claim these credits and exemptions can face allegations of misclassifying their independent contractors in order to evade their federal employment tax liability.

2. Businesses Must Report Nonemployee Compensation In Excess of $600 Annually

While businesses generally do not need to withhold taxes on nonemployee compensation, they must still report nonemployee compensation in excess of $600 annually (this threshold applies to each independent contractor individually). This is done using IRS Form 1099-NEC, Nonemployee Compensation.

3. Businesses Must Make Backup Withholdings With Respect to Nonemployee Compensation In Some Cases

In some cases, the IRS requires businesses to make “backup withholdings” with respect to nonemployee compensation. As the IRS explained in a recent Tax Tip, “Nonemployee compensation . . . is subject to backup withholding if a payee has not provided a Taxpayer Identification Number to the payer or the IRS notifies the payer that the payee provided a TIN that does not match their name in IRS records.”

4. The IRS Can Reclassify Putative Independent Contractors As Employees  

Even if a business complies with its nonemployee compensation reporting and backup withholding requirements, it can still face penalties for misclassifying its employees. The IRS can reclassify putative independent contractors, and then it can hold businesses liable for failing to satisfy their employment tax obligations.

5. Noncompliance Can Lead to IRS Scrutiny, Enforcement Action and Penalties

Regardless of the specific issue (or issues) involved, noncompliance with the federal nonemployee and employee compensation rules can lead to IRS scrutiny, enforcement action and penalties. Businesses need to prioritize compliance, and, if they have concerns, they should address these concerns before they hear from the IRS.

Discuss Your Business’ Tax Issues with Kevin E. Thorn, Managing Partner of Thorn Law Group

Tax attorney Kevin E. Thorn, Managing Partner of Thorn Law Group, has 20 years of experience representing businesses in federal tax matters. If you would like to discuss your business’s tax issues with Mr. Thorn in confidence, please call 703-752-3752, email ket@thornlawgroup.com or contact us confidentially online to schedule an initial consultation.