Many people hear that paying by cash is a good thing to help stay on budget and not overspend. Usually I would agree, however, for business owners, there are pitfalls to paying by cash. The hassle and tax implications may have you re-consider paying anyone, especially independent contractors, by cash or check, since you are required to report their income earned to the IRS.
Should You Pay Cash or Check to Independent Contractors?
To support and grow your business, did you pay any independent contractor by cash, check, wire transfer, electronic check, ACH, online bill pay (bank to bank), or direct deposit last year? If so, did you request a completed W-9 form prior to receiving services? If you weren’t aware of this IRS requirement (mentioned in Chapter 16 in Small Business Finance for the Busy Entrepreneur), you should be collecting W-9 forms from all independent contractors who you pay in total over $600 in a calendar year. It is your responsibility to mail them a 1099-Misc form by January 31st of the following year. If not, you could be fined $50 – $520 per missing form!?!
What happens if someone refuses to send you a W-9 form:
Here are three options:
- Hire someone else – If you are proactive and send the form ahead of payment and services being delivered, then you can choose to not work with the person. Find and hire another contractor who will agree to complete the W-9 form.
- Mark “REFUSED” – If you have already paid the independent contractor, then you can issue the 1099 form and put the words “REFUSED” in place of the social security number.
- Withhold 28% for IRS – If you decide to work with the independent contractor in the future, you are required to withhold back-up withholding of 28% of any amount that you pay the independent contractor. Then, you need to send that withholding to the IRS.
To be on the safe side, my CPA recommends to collect W-9 forms from all independent contractors prior to paying for service. This is really good advice since you may hire the contractor for one project at $400 in February, and then later in September hire the same contractor for $300. In this case, you would need a completed W-9 form on file (since $400 + $300 = $700; now over the $600 threshold) and would have to issue a 1099-Misc form the following year. It is much easier if you do all the necessary paperwork upfront in the business relationship because it can be awkward and contentious if the person refuses after the fact.
Real-life case story: Since I knew about the $600 threshold, I didn’t collect a W-9 form from anyone who I paid less than $600. However, at my CPA’s recent advice, I wanted to get W-9 forms from those who I paid less than $600 just to be on the safe side. One of my independent contractors refused. She had never completed any tax forms before and has not been reporting her income to the IRS because she didn’t feel like her business was making enough money yet! Yikes! You can bet that I don’t refer business to her or hire her anymore!
My CPA states that it is her responsibility to report all income that she earns, and not my problem if she doesn’t. If she doesn’t make enough income in the business, she would be exempt from self-employment tax. Luckily, my CPA says that I am safe since I paid her a total of less than $600 last year, so I am not required to have a completed W-9 form from her. However, he did suggest an option was to still issue a 1099-Misc with “Refused” in the social security section.
What to do if you pay both cash and credit:
One confusing thing that I did learn was if you paid an independent contractor through various methods of payment including both cash and credit card, then you only have to file a 1099-Misc form if the total cash payments were over $600. You would only report the amount of the cash payments, because the credit card companies and third-party networks like PayPal are required to report those payments from their side on a 1099-K.
Action Items by January 31st:
What can you do if you just learned about these requirements and have paid $600 or more to independent contractors?
- Confirm if you need to file Form 1099-Misc.
- If there is limited time to mail and receive a W-9 form, request and complete all the required forms electronically at 1099online.
- In the future, re-consider working only with independent contractors who invoice and allow credit card payments.
Again, make sure you do all of this before January 31st, or you could be fined up to $530 per return that you should have filed in the case of intentional disregard.
Have you ever had a contractor refuse to complete a W-9 form? If so, how did you handle it? If you didn’t know about these requirements until now, do you have a CPA that you are currently working with?