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In-Depth: 1099 Reporting Takes on New Prominence as Sharp Penalty Increases Take Effect.
(Parker Tax Publishing January 16, 2016)
With hefty increases in information reporting penalties (as high as $250 per late 1099) taking effect on January 1, timely issuance of 1099s has become a critical imperative for many businesses. The new urgency for timely 1099 compliance is compounded by the continued presence of questions on major tax forms asking whether the taxpayer made any payments in 2015 that would require the taxpayer to file Form(s) 1099.
Practice Aid: See Parker's CPA CLIENT LETTER: Requirement to File Forms 1099 that explains the requirement to file Form 1099 and the significance of the 1099 question on the various returns.
Increased Penalties for Failing to File Correct 1099s
Last June, Congress enacted hefty increases in the penalties imposed under Code Secs. 6721 and 6722 for failures relating to information returns and payee statements. The changes, which were included in the Trade Preferences Extension Act of 2015 (Pub. L. 114-27), took effect on January 1.
Information reporting penalties apply if a payer fails to file timely, fails to include all information required to be shown on a return, or includes incorrect information on an information return (including all variations of Form 1099).
The amount of the penalty is based on when the correct information return is filed. For returns required to be filed for the 2015 tax year, the penalty is:
(1) $50 per information return for returns filed correctly within 30 days after the due date (up from $30 under the prior law), with a maximum penalty of $500,000 a year ($175,000 for certain small businesses);
(2) $100 per information return for returns filed more than 30 days after the due date but by August 1 (up from $60 under prior law), with a maximum penalty of $1,500,000 a year ($500,000 for certain small businesses); and
(3) $250 per information return for returns filed after August 1 or not filed at all (up from $100 under prior law), with a maximum penalty of $3,000,000 a year for most businesses but $1,000,000 for certain small businesses.
For purposes of the lower penalty, a business is a small business for any calendar year if its average annual gross receipts for the three most recent tax years (or for the period it was in existence, if shorter) ending before the calendar year do not exceed $5 million.
OBSERVATION: This year's increase in information return penalties represents the second time in just a few years that Congress has enacted sharp increases. For 1099s filed after August 1 or not filed at all, taxpayers face a 500% increase in the per-item penalty compared with the pre-2010 amount.
Persons who are required to file information returns electronically but who fail to do so (without an approved waiver) are treated as having failed to file the return unless the person shows reasonable cause for the failure. However, they can file up to 250 returns on paper; those returns will not be subject to a penalty for failure to file electronically. The penalty applies separately to original returns and corrected returns.
The penalty also applies if a person reports an incorrect taxpayer identification number (TIN) or fails to report a TIN, or fails to file paper forms that are machine readable.
The penalty for failure to include the correct information on a return does not apply to a de minimis number of information returns with such failures if the failures are corrected by August 1 of the calendar year in which the due date occurs. The number of returns to which this exception applies cannot be more than the greater of 10 returns or 0.5 percent of the total number of information returns required to be filed for the year.
If a failure to file a correct information return is due to an intentional disregard of one of the requirements (i.e., it is a knowing or willing failure), the penalty is the greater of $500 per return or the statutory percentage of the aggregate dollar amount of the items required to be reported (the statutory percentage depends on the type of information return at issue). In addition, in the case of intentional disregard of the requirements, the $5,000,000 limitation does not apply.
The Protecting Americans from Tax Hikes Act (Pub. L. 114-113) added a safe harbor from the application of these penalties in circumstances in which the information return or payee statement is otherwise correctly filed but includes a de minimis error of the amount required to be reported on such return or statement. In general, a de minimis error of an amount on the information return or statement need not be corrected if the error for any single amount does not exceed $100. A lower threshold of $25 is established for errors with respect to the reporting of an amount of withholding or backup withholding.
1099 Question Remains on Major Tax Forms
The 2015 Forms 1065, 1120, 1120S, and 1040, Schedules C, E, and F, all contain questions asking if the taxpayer made any payments in 2015 that would require the taxpayer to file Form(s) 1099. If the answer is "yes," then the IRS wants to know if the taxpayer did, or will, file the required Forms 1099.
The questions first showed up in 2011 and practitioners immediately expressed concern that their clients may not be aware of the full ramifications of incorrectly reporting Form 1099 income and the impact on their own liability for checking these boxes. If a client reports that all Form 1099s were filed when they were not, he or she is committing perjury (because the returns are signed under penalties of perjury). If the client reports that not all Form 1099s were filed, then that's a red flag for an audit.
If a taxpayer has a business that uses sporadic labor, the Form 1099 questions can present a dilemma in certain situations. For example, how does a taxpayer who intermittently employs workers by picking them up at places where such workers congregate, answer the questions? If any of these workers are used several times during the year in the taxpayer's business, the amounts paid to that worker will most likely exceed $600, and the taxpayer will be responsible for issuing a Form 1099-MISC to that independent contractor. What if the workers will accept only cash? Without proper documentation, how does the taxpayer prove that no one individual was paid more than $600?
With the penalties once again sharply increasing for information returns and payee statements filed in 2016, these questions are more relevant than ever.
Form 1099-MISC
Generally, any person, including a corporation, partnership, individual, estate, and trust, which makes reportable transactions during the calendar year, must file information returns to report those transactions to the IRS. However, a payer does not need to file Form 1099-MISC for payments not made in the course of the payer's trade or business. A payer is engaged in a trade or business if it operates for gain or profit. Thus, personal payments are not reportable. Nonprofit organizations are considered to be engaged in a trade or business and are subject to the reporting requirements. For other exceptions to filing a Form 1099-MISC, see ¶252,565.
The type of reportable transaction determines the specific Form 1099 that must be filed. Most of the issues revolving around the filing of Forms 1099, involve Form 1099-MISC and the reporting of non-employee compensation. In general, a payer must file Form 1099-MISC, Miscellaneous Income, for each person to whom the payer has paid during the year:
(1) at least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest;
(2) at least $600 in rents, services (including parts and materials), prizes and awards, other income payments, medical and health care payments, crop insurance proceeds, cash payments for fish (or other aquatic life) purchased from anyone engaged in the trade or business of catching fish, or, generally, the cash paid from a notional principal contract to an individual, partnership, or estate;
(3) any fishing boat proceeds; or
(4) gross proceeds to an attorney.
In addition, Form 1099-MISC must be filed to report direct sales of at least $5,000 of consumer products made to a buyer for resale anywhere other than a permanent retail establishment. Form 1099-MISC must also be filed for each person from whom a taxpayer has withheld any federal income tax under the backup withholding requirement (discussed below), regardless of the amount of the payment.
Compliance Tip: The deadline for filing paper Forms 1099-MISC is generally the last day of February following the calendar year for which the filing is made. The due date is extended until the last day of March for payers who file electronically. If the regular due date falls on a Saturday, Sunday, or legal holiday, Form 1099-MISC is due the next business day.
Backup-Withholding Requirement
A backup withholding requirement applies to reportable payments where the payee does not furnish a taxpayer identification number (TIN). The backup withholding rate is equal to 28 percent of the amount paid. The requirement does not apply to payments made to tax-exempt, governmental, or international organizations.
In determining whether a payee has failed to provide a TIN, a payer is required to process the TIN within 30 days after receiving it from the payee or in certain cases, from a broker. Thus, the payer may take up to 30 days to treat the TIN as having been received.
Can IRS Limit Deductions to $600 Where No Form 1099 Is Filed?
Some practitioners have questioned whether or not the IRS can limit a compensation deduction to $599, the cutoff for not reporting nonemployee compensation, where a Form 1099-MISC is not filed. While there is nothing in the Code or regulations on this, nor is there any case law on point, some practitioners have reported IRS agents telling them that if they had not produced Form 1099s for compensation deductions taken on a return, the nonemployee compensation deduction would be limited to an amount not required to be reported on Form 1099-MISC.
What Constitutes a Trade or Business That Requires Reporting on Form 1099?
The characterization of an activity as a "trade or business" took on a new importance in 2013 with the implementation of the net investment income tax. Effective for tax years beginning after December 31, 2012, individuals are subject to a 3.8 percent tax on the lesser of net investment income or the excess of modified adjusted gross income over a threshold amount. Generally, income from a trade or business (with the exception of certain commodities trading income) is exempt from the net investment income tax.
As previously mentioned, taxpayers not in a trade or business are not required to file Form 1099s. Whether a taxpayer is considered to be in a trade or business has become a hot topic because of the net investment income tax. As a result, taxpayers may be claiming that their activity is not subject to the net investment income tax because it rises to the level of a trade or business without considering the impact that will have on their Form 1099 filing requirements and the associated penalties if such forms are not filed.
Conclusion
Practitioners should advise their clients to have non-employee workers or contractors complete a Form W-9 if they believe payments to any individual might add up to $600 or more for the year. To the extent anyone is paid more than $600, a Form 1099-MISC should then be issued at the end of the year. Practitioners should also document in their files that they've had this discussion with clients and may want to consider revising their engagement letter to reflect the documentation a client will need to take certain deductions on the return. Similarly, practitioners may want to warn their clients about the trade-offs for claiming they are in a trade or business in an effort to escape the net investment income tax and their responsibility for filing Form 1099s when they are in a trade or business. (Staff Editor Parker Tax Publishing)
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
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