Q. (cont.) The checks are sent to the contractor who endorses it, and then forwards to the subcontractor to endorse and deposit. What is the best practice when paying contractors for subcontractor work?
A. There are issues with two-party checks, including the vendor file setup and record history and potential complication of 1099 reporting; if we’re talking multiple subcontractors, it can get very complicated. As a consequence, some think it is not a good practice to cut a check with the names of both the contractor and subcontractor on the face of the check. However, especially in construction, the practice is not at all uncommon.
Two-party checks require the signatures of both parties to be cashed. That is why a subcontractor sometimes requires a two-party check, so that they can be sure payment is received for their services instead of the general contractor spending the money elsewhere. An alternative to this, of course, is for you to pay the subcontractors directly. (Subcontractors can put liens on property if they have not been paid. Lien laws vary by state. But using two-party checks can be a solution to avoiding that.) Of course, a dual-party check also serves to keep the general contractor apprised of (and still responsible for) payments to the subcontractor.
As far as vendor setup and 1099 reporting, according to past conversations with the IRS, how you approach that has to do with whether you know and indicate the split between the general contractor and the subcontractor or not. If you simply write the check with the full amount, name both parties and payees, and send the check to the general contractor, then you issue a 1099 for the full amount to the GC and none to the subcontractor. Therefore, you can add the subcontractor to the general contractor vendor master file record as a remit-to. The GC has the responsibility to issue a 1099 for the payment to the subcontractor.
However, as we understand the IRS, if you know and indicate the split on the check, then you have to issue a 1099 to the GC and a 1099 to the subcontractor, each for their portion of the payment. Of course in that case, you will have to set up the subcontractor as a separate vendor in the VMF.
We are not certain, but from your description, it sounds as though you are managing payments to the sub through the general contractor, and so would just have to send one 1099 to the GC, who then has a responsibility as a “middleman” to issue a 1099 to the subcontractor for the portion of the money that the GC then gives to the sub (which in your case seems to be all of it).
You may want to see 1099: Assignment of Income and Middleman Regulations – The Middleman Regulation, which is the regulation under which the GC is responsible for reporting the payment to the sub on a 1099.