Most of the people landlords hire to help them are independent contractors (ICs) who offer their services to the general public, as opposed to employees who work solely for you. ICs include:
- construction contractors
- carpet layers
- roofers, and
- people who provide professional services to the public, such as real estate brokers, real estate appraisers, architects, real estate management companies, lawyers, accountants, and bookkeepers.
As far as taxes are concerned, hiring independent contractors is very simple. When you hire an independent contractor, you don’t have to withhold or pay any state or federal payroll taxes on the IC’s behalf. This is one of the great benefits of hiring ICs. In contrast, when you hire an employee you must withhold federal and state taxes and pay one-half of the worker’s Social Security and Medicare taxes out of your own pocket.
However, there is one tax detail you will have to take care of when you hire an IC: If you pay an unincorporated IC $600 or more during the year for business-related services, you must:
- file IRS Form 1099-MISC telling the IRS how much you paid the worker, and
- obtain the IC’s taxpayer identification number.
The IRS imposes these requirements because it is very concerned that to avoid paying taxes, many ICs don’t report all the income they earn. To help prevent this, the IRS wants to find out how much you pay ICs you hire and make sure it has their correct tax ID numbers.
Threshold for IC Income Reporting on IRS Form 1099
You need to obtain an unincorporated IC’s taxpayer ID number and file a 1099 form with the IRS only if you pay the IC $600 or more during a year for rental-related services. It makes no difference whether the sum was one payment for a single job or the total of many small payments for multiple jobs.
In calculating whether the payments made to an IC total $600 or more during a year, you must include payments you make for parts or materials the IC used in performing the services. For example, if you hire an electrician to rewire a rental building and he charges you separately for the electrical wiring and other materials he installs, the cost must be included in the tally. However, not all payments you make to ICs are counted toward the $600 threshold.
Payments for Merchandise
Under current law, you don’t need to include in the $600 threshold payments you make solely for merchandise.
Payments for Personal Services
You need only count payments you make to ICs for services they perform in the course of your rental activity. You don’t count payments for services you make to ICs for personal or household services or repairs—for example, payments to gardeners and housekeepers for your personal residence. Running your home is not a rental activity.
Filing IRS Form 1099
The IRS wants to know how much ICs earn each year so it can make sure they are reporting all their income. This is accomplished by requiring people and companies that hire ICs to report the amount of their payments to the IRS on IRS Form 1099-MISC. You must file a 1099-MISC form for each IC you paid $600 or more during the year. You must obtain original 1099 forms from the IRS for filing. You cannot photocopy this form because it contains several pressure-sensitive copies. Each 1099 form contains three parts and can be used for three different workers. All your 1099 forms must be submitted together along with one copy of Form 1096, which is a transmittal form—the IRS equivalent of a cover letter. You must obtain an original Form 1096 from the IRS; you cannot submit a photocopy. Obtain these forms by calling the IRS at 800-TAX-FORM or by contacting your local IRS office. You can also obtain usable 1099 forms from stationery stores and office supply companies.
Obtaining Taxpayer Identification Numbers
Some ICs work in the underground economy—that is, they’re paid in cash and never pay any taxes or file tax returns. The IRS may not even know they exist. The IRS wants you to help it find these people by supplying the taxpayer ID numbers from all ICs who meet the requirements explained above.
If an IC won’t give you his or her number or the IRS informs you that the number the IC gave you is incorrect, the IRS assumes the person isn’t going to voluntarily pay taxes. So it requires you to withhold taxes from the compensation you pay the IC and remit them to the IRS. This is called backup withholding. If you fail to backup withhold, the IRS will impose an assessment against you equal to 28% of what you paid the IC.
How to Avoid Backup Withholding
Backup withholding can be a bookkeeping burden for you. Fortunately, it’s very easy to avoid it. Have the IC fill out and sign IRS Form W-9, Request for Taxpayer Identification Number, and retain it in your files. (You can obtain a copy of the form by calling the IRS at 800-TAX-FORM, by contacting your local IRS office, or by downloading it from the IRS website.)
You don’t have to file the W-9 with the IRS. This simple form merely requires the IC to list his or her name and address and taxpayer ID number. Partnerships and sole proprietors with employees must have a federal employer identification number (EIN), which they obtain from the IRS. In the case of sole proprietors without employees, the taxpayer ID number is the IC’s Social Security number.
For a list of other documents to obtain when hiring ICs, see Require Documentation When You Hire Independent Contractors.
More Information on Hiring Independent Contractors
For details on the advantages of hiring independent contractors, see Pros and Cons of Hiring Independent Contractors. For guidance on how to determine whether a worker is an employee or an IC, see Independent Contractor or Employee: How Government Agencies Make the Call. For related articles, see the Employment Law Center on the Nolo site.
For a comprehensive guide to tax issues affecting landlords, including tax-related questions when hiring help, see Every Landlord's Tax Deduction Guide, by Stephen Fishman (Nolo).