Beware of state equivalent 1099 filing obligations

ARTICLE | December 22, 2023

Authored by RSM US LLP

Executive summary

As the year closes and companies prepare to file federal forms 1099, many will overlook state equivalent 1099 filing requirements which can be extremely complex, are subject to change, and often vary by state and form type.  Take the time now to evaluate your state 1099 filing requirements by confirming that your budget, resources and compliance program are up to par for managing increasing risk and evolving changes.

Beware of state equivalent 1099 filing obligations

Companies operating a U.S. trade or business and controlled foreign corporations that make certain reportable payments to U.S. persons who are not their employees (including vendors, investors and related entities) must be prepared to file U.S. tax information returns.  While many are aware of the U.S. federal requirement to file tax information returns, an area that is frequently overlooked and that can result in material exposure is the requirement to file state equivalent forms 1099.

Many states  require direct filing of state equivalent information returns and  may also have different reporting thresholds and filing deadlines than  federal requirements and that vary by state.  For example, when the IRS released Notice 2023-74  earlier this year announcing the delayed implementation of the lower $600 threshold for filing Forms 1099-K, (see our prior article) many states did not follow suit or were slow to issue guidance, leaving payment processors and on-line marketplaces scrambling to understand and manage their state equivalent form 1099-K filing obligations.  It is therefore important that you that monitor and are aware of your state filing obligations.  Plan to discuss them with your tax advisor or other service provider early to confirm that they have the ability to file the forms and that you have allocated sufficient lead time and budget for managing your state  filing obligations.

What states require direct reporting?

While most states will accept the federal form 1099 and do participate in the Combined Federal/State Filing Program (CF/SF), most still require a separate filing if there’s state withholding tax deducted, and some states do not participate in the program as they prefer not to wait for the IRS to share information with them.  Under the CF/SF Program, the IRS forwards original and corrected information returns filed electronically to participating states free of charge for approved filers, thereby eliminating the need for separate reporting to the participating states.  The IRS created the Combined Federal/State Filing program as a mechanism for sharing data from information returns with the states.

• As of 2023, the following states participate in the CF/SF program: Alabama, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Georgia, Hawaii, Idaho, Indiana, Kansas, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New Jersey, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, Wisconsin. States that are not listed either do not participate in the program at all, may still require taxpayers to submit a copy of the form even if they participate, or may require direct reporting of certain 1099 series forms and not others.
• The following states do not participate in the CF/SF program: Florida, Iowa, Illinois, Kentucky, Oregon, Pennsylvania, Rhode Island, Tennessee, Utah, Virginia, West Virginia, Vermont and District of Columbia.  These states all require that forms be filed directly to the state, so be sure to confirm that your 1099 vendor will file these forms on your behalf.
• The states below participate in the CF/SF program but have certain state specific requirements that filing via the CF/SF does not satisfy: Alabama, Arizona, Connecticut, Delaware, Georgia, Indiana, Kansas, Louisiana, Maryland, Michigan, Minnesota, Mississippi, Montana, North Carolina, North Dakota, Ohio, South Carolina, Wisconsin. Filers must verify filing requirements with the state, which are subject to change. Again, these states participate in the CF/SF, but often have limited options for how information received from the IRS can be used. As such, in order to track, audit and compare all withholding information, filers must provide certain information directly to the state. 

Direct state reporting for 1099s is a complex space, with changes happening annually for individual states and form types.  New reporting requirements, CF/SF participation changes, changing form thresholds and filing methods are just a few examples that businesses must keep in mind when filing forms 1099.

Most commonly filed Forms 1099-NEC present specific challenges

One of the most common and frequently filed information returns is IRS Form 1099-NEC, Nonemployee Compensation.  Companies that paid compensation for services of $600 or more last year to a U.S. person that is not its employee (such as a vendor or independent contractor) must file IRS Form 1099-NEC, Nonemployee Compensation with the IRS and must furnish copies of the forms to recipients by Jan. 31 annually.  Form 1099-NEC is used to report nonemployee compensation, such as payments for services to independent contractors, commissions, board of director fees, legal fees paid  to attorneys (excluding gross proceeds) and other forms of compensation or benefits for services rendered by a nonemployee. Refer to our prior article for more details.  

Form 1099-NEC was added to the CF/SF Program a few years ago, so in most cases, the IRS will share information from the forms with certain states that participate in the CF/SF Program.  However, many states  still require taxpayers to file a separate 1099-NEC form directly to  state taxing authorities.  Further, while some states, such as California, previously indicated when the form was first introduced that they would not impose penalties for failing to file state equivalent forms 1099-NEC, recently more states are imposing penalties and performing compliance inquiries.  It is therefore imperative that companies evaluate their state filing obligations now to avoid penalties and manage risk as they may need to file 1099-NEC forms to the IRS and to several states.  Requirements vary by state and are subject to change.

Other practical considerations

There are also many practical considerations and challenges to navigate with respect to state equivalent forms 1099-NEC.  For example, most states that do require reporting, such as Virginia, only require that a 1099-NEC form is filed if state tax was withheld while other states require the forms if the payee is resident in the state or if services were performed in the state.  However, many companies do not track such data and may opt to report only to the state of the recipient’s address of record, which may not render an accurate result based on each states’ rules.  Finally, many states require withholding agents to register if they have workers in the state and in order to file 1099-NEC, so companies need time to register and may face delays. Registering in a state may have nexus and other state relevant implications, so please consult with a member of our State and Local Tax (SALT) team prior to doing so.

Managing multiple filing deadlines is also a challenge. Guidance for each state, which is subject to change as many states have not published updated guidance yet this year, is available below:

Companies must develop a process for managing risk and ongoing monitoring of their state information return filing obligations.