Does Your Maryland Business Use Independent Contractors? What to Know about Nonemployee Compensation Tax Compliance

While most business owners know that there are tax advantages to using independent contractors, many business owners are not aware of the federal tax rules governing nonemployee compensation. Paying independent contractors can still trigger annual reporting obligations, and businesses that use independent contractors are still required to make withholdings in some cases.

Understanding the Tax Implications of Paying Independent Contractors in Maryland

The Internal Revenue Service (IRS) recently issued a Tax Tip on the topic of nonemployee compensation. Here are some of the key takeaways for business owners in Maryland:

1. Businesses Must Report Annual Payments to Independent Contractors in Excess of $600

While independent contractors must report their income to the IRS using IRS Form 1099, businesses that pay independent contractors have reporting obligations as well. Specifically, if a business pays $600 or more to an independent contractor during a tax year, it must report the payments to the IRS using IRS Form 1099-NEC.

2. Businesses Must Make “Backup Withholdings” for Some Independent Contractors

As the IRS explains in its Tax Tip, “there are situations when [a] payer is required to withhold a certain percentage of tax to make sure the IRS receives the tax due on this income” from an independent contractor. This is referred to as a “backup withholding,” and the backup withholding rate is 24 percent as of 2022. In most cases, the backup withholding requirement comes into play for businesses when they fail to collect accurate taxpayer identification numbers (TINs) from independent contractors.  

3. The IRS Can Reclassify “Independent Contractors” as Employees

When it comes to determining whether a worker is an employee or an independent contractor, the IRS has the final say. The IRS has established a list of factors for determining proper worker classification, and businesses must use this list to make informed decisions. However, even if a business does its best to properly classify its workers, the IRS can still reach the opposite conclusion. When this happens, the IRS can impose liability for past-due employment taxes, interest and penalties.

4. Independent Contractor Payments Don’t Count Toward Employment-Related Credits and Exemptions

While payments to independent contractors are not subject to employment tax law compliance, they also do not qualify for employment-related credits and exemptions. When calculating these credits and exemptions, Maryland businesses must be very careful to ensure that they are only using payments made to bona fide employees.

5. Nonemployee Compensation Violations Can Trigger IRS Scrutiny for Maryland Businesses

When Maryland businesses improperly classify their workers, fail to make backup withholdings, improperly claim credits and deductions, and make other mistakes related to nonemployee compensation, this can trigger scrutiny from the IRS. Audits and investigations can lead to substantial penalties for businesses—and, in some cases, business owners can face liability as well.

Request an Appointment with Tax Attorney Kevin E. Thorn in Maryland

If you need to know more about the tax laws regarding nonemployee compensation, we invite you to schedule a consultation at Thorn Law Group. To request an appointment with tax attorney and Managing Partner Kevin E. Thorn, please call 240-235-5096, email ket@thornlawgroup.com or contact us confidentially online today.