Last year the IRS took an aggressive step to ratchet up its ability to enforce business compliance with annual 1099 income reporting regulations. Today I will discuss form 1099-Misc and these enforcement changes. I will also share the potential consequences for not filing these annual reports and how to stay out of the IRS’s enforcement cross-hairs.
1099 Self-Incriminate-Reporting: In 2011, two seemingly-innocent questions were added to all business tax returns. These questions are:
Worried that you may not be in compliance with form 1099-MISC? Check out our 1099-MISC Basics course to get all of your compliance questions answered.
The taxpayer is then required to check the box “yes” or “no,” a response made under penalty of perjury when the taxpayer signs the return.
Why is this Significant? The 1099 Form series is a major part of the IRS’s Information Reporting Program (including forms W2 for wages and K-1, reporting partner and S Corp shareholder income and deductions) which tracks payments made by businesses to other taxpayers. The Information Reporting Program enforces the common taxation rule: The expense of one taxpayer is generally income to another.
The primary role of Form 1099 is to “inform” the IRS of income taxpayers receive. The IRS enters 1099 data into computers that match it against income reported on taxpayers’ returns. Any income shortfall reported by the taxpayer will automatically generate a letter and/or a bill for tax due, plus penalties and interest.
The system is so effective that, if everyone followed the information reporting rules (and deductions did not exist such as with a flat tax), the IRS could simply send taxpayers a bill for their income tax each year. This, in fact, is the procedure for taxpayers who fail to file their income tax returns.
Small Business and Form 1099 Compliance: Although there are many 1099 forms, the most common one completed by small businesses is Form 1099-Misc, which reports self-employment income paid to unincorporated vendors, contractors, and casual labor totaling $600 or more in any given year. The addition of these questions is an attempt to close the portion of the $450 billion tax gap (the difference between taxes paid each year and taxes actually owed to the US Treasury) attributable to small businesses’ persistent non-compliance.
Back-up Withholdings and Form 1099: In order to issue forms 1099, businesses must obtain the Taxpayer Identification Number (TIN) from their service providers. Generally, this is done by providing Form W-9, Request for Taxpayer Identification, to the individual and/or business to which payments will be made. If the service provider fails to provide the requested TIN, the payer may be required to remove “backup withholdings” (currently 28%) from any payments due the provider, and remit these amounts to the IRS.
The Penalty-Trap: The basic penalty for not filing forms 1099 is generally $50 per unfiled return. This penalty, however, increases to the greater of $100 per return or 10% of the total amount that should have been reported if the IRS believes the failure was due to intentionally disregarding 1099 reporting rules. And herein lays the penalty-trap: If a business affirmatively states that they were required to file forms 1099 but fails to do so, they have intentionally disregarded the 1099 reporting rules. If, on the other hand, the business states that they were not required to file Form 1099 and it is later shown that they were, the business has intentionally disregarded the 1099 reporting rules and lied on its tax return.
An additional fear which looms among many professionals is that these developments may set the stage for what to-date has been a relatively rare penalty: Failure to collect and remit the 28% backup withholdings mentioned above. This penalty carries the same weight as the payroll taxes and is equal to the 28% tax that should have been withheld.
The Take Away: If you have not already done so, make a pre-New Year’s resolution to avoid the penalties listed above by following the Form 1099 reporting rules. The form deadlines are January and February each year.
Please remember: This or any article does not constitute or replace the advice of a qualified professional. If you have any questions regarding your taxes or would like assistance in preparing your tax returns, please feel free to call our office at (304) 267-2594.
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