Question: Can a company issue both a Form 1099 and a Form W-2 to a worker in the same year, or is this a red flag for the IRS?
Answer: The Form W-2, Wage and Tax Statement, is used to report wage income. The Form 1099 series is used to report nonwage income. Generally, if the work and the working relationship between the worker and the company are essentially the same, then all income should be reported on the same form. However, situations exist in which issuing both forms to the same person may be appropriate.
Workers may be classified as common-law employees, statutory employees, statutory nonemployees, or independent contractors. Some compensated activities do not rise to the level of employment or of a trade or business. For example, compensation for participating in a medical research study is taxable but is not generally considered to be employment, a trade, or a business. Such payments are reported on Form 1099-MISC, Miscellaneous Income.
Generally, common-law employees and statutory employees receive a Form W-2, and statutory nonemployees and independent contractors receive a Form 1099-MISC or Form 1099-NEC, Nonemployee Compensation.
The four classes of statutory employees are described in IRS Publication 15-A, Employers Supplemental Tax Guide. Statutory employment status is contingent upon specific conditions. The workers are treated as employees for Social Security, Medicare and FUTA purposes, but they are treated as nonemployees for income tax purposes. While compensation is reported on Form W-2, no income tax is withheld, and the worker reports the compensation on Form 1040 Schedule C, Profit or Loss From Business (Sole Proprietorship).
Three classes of statutory nonemployees are also described in Publication 15-A. Such workers are treated as nonemployees regardless of any common-law factors. Independent contractors are nonemployees under the common law. Both groups should receive Forms 1099 reporting their compensation.
Sometimes a particular worker may fall into more than one classification for a particular employer.
Common-law employee and independent contractor: A company discovers that one of its bookkeepers is an artist and commissions the person to create a painting for the company reception area. The company should issue the worker a Form W-2 reflecting the wages earned as staff bookkeeper and a Form 1099-NEC reflecting payment to an independent contractor for the artwork.
Common-law employee and statutory nonemployee: A licensed real estate agent splits time at a brokerage working part-time in sales and part time as a receptionist. For the work in sales, the worker is classified as a statutory nonemployee, and the brokerage would report income on Form 1099-NEC. For the work as a receptionist, the worker would be a common-law employee, and the company would report the income on Form W-2.
Common-law employee and self-employment: A self-employed plumber occasionally makes plumbing repairs for a local college. During the same year, the plumber is hired as an adjunct faculty member in the college’s skilled trades program. The college should issue the worker a Form 1099-NEC for the contract plumbing work and a Form W-2 for the faculty work.
Common-law employee and unrelated income: A student is enrolled in a program that involves work-study and is paid by the college. That same year, the student receives a taxable award for academic excellence that is independent of the employment. The college should issue the student a Form W-2 for the work-study and a Form 1099-MISC for the academic award.
There are situations in which issuing both a Form 1099 and a Form W-2 to the same worker is inappropriate. Often, this is done to reduce the employer’s tax burden by treating employment as nonemployment.
A retail salesperson is paid wages and commissions. The employer reports the wages on Form W-2 and the commissions on Form 1099-NEC. This is not in compliance because the wages and commissions are both compensation paid to a common-law employee. For employees, all forms of compensation are considered wages for reporting purposes. This includes hourly wages, salary, bonuses, commissions, noncash compensation, and taxable fringe benefits.
An employer has cash flow problems and converts all employees to independent contractors for the fourth quarter, paying their regular net pay amounts and reporting the payments on 1099-NEC forms. The pay for the first three quarters is reported on Forms W-2. The workers perform the same duties under each payment scheme; so, the employees are still common-law employees. All earnings should have been reported on Form W-2. In this situation, because the employer paid the workers their regular net pay, the employer also effectively withheld employee taxes and failed to pay them to the IRS, which is a separate offense.
The line between common-law employment and common-law nonemployment is not always clear. An employer might inadvertently treat common law employees as independent contractors. If the employer acts in good faith and reports the payments by issuing the appropriate Forms 1099 to the workers, the employer might be able to rely on special rules to mitigate penalties in the event the workers are reclassified as employees.
This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at firstname.lastname@example.org.
Do you have a question for Payroll in Practice? Send it to email@example.com.
To contact the editor on this story: