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February 1 Deadline Looms for Forms W-2 and 1099-MISC, and New Form 1099-NEC
(Parker Tax Publishing January 2021)
While the deadline for sending Forms W-2 and 1099 to employees and payees remains the same as past years, the reporting routine for 2020 has been changed by the IRS's introduction of Form 1099-NEC, which is required for payments of over $600 of non-employee compensation (NEC) made in the course of a taxpayer's trade or business. The change is expected to reduce confusion about the deadline for filing Forms 1099 with the IRS.
Practice Aid: For a CLIENT LETTER which explains the requirement to file Form 1099. Click here.
Observation: In prior years, payments of NEC were reportable on Form 1099-MISC in Box 7. If there was no amount reported in Box 7, then Form 1099-MISC was required to be filed with the IRS by February 28. However, if Form 1099-MISC had an amount in Box 7, then it was due to the IRS by January 31. Thus, starting with the 2020 forms, there will be only one deadline (March 1 this year) for filing paper Forms 1099-MISC with the IRS. Forms 1099-NEC must be filed with the IRS by January 31 (February 1 this year).
A major reason for staying on top of these deadlines is that taxpayers may be subject to a penalty where they: (1) don't file a correct information return by the due date and reasonable cause for the failure is not shown; (2) file on paper when they are required to file electronically; (3) fail to report a taxpayer identification number (TIN); (4) report an incorrect TIN; or (5) fail to file paper forms that are machine readable.
Observation: It's important to note that some Form 1099 filing requirements may be triggered by taxpayer strategies used in avoiding the net investment income tax (NIIT) or claiming eligibility for the Code Sec. 199A deduction. The requirements to file Forms 1099-MISC or 1099-NEC depend on whether a taxpayer is engaged in a trade or business and a taxpayer's liability for filing Forms 1099-MISC or 1099-NEC can also have other tax impacts. While taxpayers may want to escape liability for filing these forms by claiming they are not engaged in a trade or business, that can hurt them if (1) they want to avail themselves of the Code Sec. 199A deduction, which is only available to a trade or business, or (2) they want escape the reach of the NIIT (discussed below), which generally excepts a trade or business from the tax.
Filing Deadlines for Forms W-2 and Forms 1099-NEC and 1099-MISC
This tax season, January 31 falls on a Sunday, so forms ordinarily due January 31 are due to recipients or the IRS the next business day, Monday, February 1, 2021. Taxpayers that are required to report 2020 payments of NEC must file Forms 1099-NEC with the IRS and with recipients on or before February 1, 2021, using either paper or electronic filing procedures. Taxpayers that are not reporting NEC must file Form 1099-MISC with recipients by February 1 and with the IRS by March 1, 2021, if filing on paper, or March 31, 2021, if filing electronically.
Extensions of time are available for filing Form 1099-NEC and Form W-2 with the IRS, if taxpayers can't make the February 1 deadline. The request for an extension of time to file Form 1099-NEC must be filed on the paper version of Form 8809, Application for Extension of Time to File Information Returns. Form 8809 is also used to request extensions of time to file Form W-2. One 30-day extension to file Form 1099-NEC or Form W-2 may be requested. However, it's important to note that the extension of time does not extend the time for furnishing statements to recipients.
Form 1099-NEC
Form 1099-NEC, Nonemployee Compensation, must be filed for each person in the course of the taxpayer's trade or business to whom at least $600 was paid during the year for:
(1) services performed by someone who is not the taxpayer's employee (including parts and materials);
(2) each person from whom you have withheld any federal income tax (report in box 4) under the backup withholding rules regardless of the amount of the payment
(3) cash payments for fish (or other aquatic life) purchased from anyone engaged in the trade or business of catching fish; or
(4) payments to an attorney (not including gross proceeds).
Form 1099-NEC must also be filed for each person from whom any federal income tax was withheld in 2020, regardless of the amount of the payment.
Some payments that may be taxable to the recipient are not required to be reported on Form 1099-NEC, including:
(1) payments to a corporation (including an LLC that is treated as a C or S corporation);
(2) payments of rent to real estate agents or property managers (however, the real estate agent or property manager must use Form 1099-MISC to report the rent paid over to the property owner);
(3) business travel allowances paid to employees and employee business expense reimbursements; and
(4) cancelled debts under Code Sec. 6050P (cancelled debts must be reported on Form 1099-C, Cancellation of Debt).
Form 1099-MISC
Payments are reported on Form 1099-MISC (the name of which has been changed from "Miscellaneous Income" to "Miscellaneous Information") when made in the course of a taxpayer's trade or business. A taxpayer is considered engaged in a trade or business if the taxpayer operates for gain or profit. Nonprofit organizations are considered to be engaged in a trade or business and, thus, are subject to these reporting requirements. Other organizations subject to these reporting requirements include trusts of qualified pension or profit-sharing plans of employers, certain organizations exempt from tax under Code Sec. 501(c) or Code Sec. 501(d), farmers' cooperatives that are exempt from tax under Code Sec. 521, and widely held fixed investment trusts. Payments by federal, state, or local government agencies are also reportable.
A payer does not need to file Form 1099-MISC for payments not made in the course of the taxpayer's trade or business. Thus, personal payments are not reportable. A payer is engaged in a trade or business if the payer operates for gain or profit.
The following payments do not need to be reported on Form 1099-MISC:
(1) generally, payments to a corporation (including a limited liability company (LLC) that is treated as a C or S corporation);
(2) payments for merchandise, telegrams, telephone, freight, storage, and similar items;
(3) payments of rent to real estate agents or property managers (however, the real estate agent or property manager must use Form 1099-MISC to report the rent paid over to the property owner);
(4) wages paid to employees (reportable instead on Form W-2, Wage and Tax Statement);
(5) military differential wage payments made to employees while they are on active duty in the Armed Forces or other uniformed services (reportable on Form W-2);
(6) business travel allowances paid to employees (may be reportable on Form W-2);
(7) cost of current life insurance protection (reportable on Form W-2 or Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.);
(8) payments to a tax-exempt organization including tax-exempt trusts (IRAs, HSAs, Archer MSAs, Coverdell ESAs, and ABLE (529A) accounts), the United States, a state, the District of Columbia, a U.S. possession, or a foreign government;
(9) payments made to or for homeowners from the HFA Hardest Hit Fund or a similar state program (reportable on Form 1098-MA);
(10) compensation for injuries or sickness by the Department of Justice as a public safety officer disability or survivor's benefit, or under a state program that provides benefits for surviving dependents of a public safety officer who has died as the direct and proximate result of a personal injury sustained in the line of duty; and
(11) compensation for wrongful incarceration for any criminal offense for which there was a conviction under federal or state law.
The type of reportable transaction determines the Form 1099 that must be filed. In general, a payer must file Form 1099-MISC to report for each person in the course of the taxpayer's trade or business to whom the taxpayer has paid at least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest and/or at least $600 in:
(1) rents (box 1);
(2) prizes and awards (box 3);
(3) other income payments (box 3);
(4) generally, the cash paid from a notional principal contract to an individual, partnership, or estate (box 3);
(5) any fishing boat proceeds (box 5);
(6) medical and health care payments (box 6);
(7) crop insurance proceeds (box 9);
(8) gross proceeds paid to an attorney (box 10) (see Payments to attorneys, later);
(9) Code Sec. 409A deferrals (box 12); or
(10) nonqualified deferred compensation (box 14).
Observation: In a change from 2019, payers may use either Box 2 on Form 1099-NEC or Box 7 on Form 1099-MISC to report any sales totaling $5,000 or more of consumer products for resale, on buy-sell, deposit-commission, or any other basis.
Strategies to Avoid the NIIT or to Claim Eligibility for the Sec. 199A Deduction May Trigger 1099 Filing Requirements
As previously mentioned, taxpayers not in a trade or business are not required to file Form 1099s, but the characterization of not being in a trade or business can also hurt certain taxpayers. The characterization of an activity as a "trade or business" is important not only in deciding whether a business must file Forms 1099, but also in determining if income from an activity is subject to the NIIT. 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 NIIT. Taxpayers taking the position that their activity is not subject to the NIIT because it rises to the level of a trade or business, need to be aware of the Form 1099 filing requirements that come with an activity having trade or business status.
Similarly, taxpayers arguing that their activity is not a trade or business aren't eligible for the Code Sec. 199A deduction because it is only available to a qualified trade or business.
Penalties for Failing to File Correct and Timely Forms 1099s
Information reporting penalties apply if a payer fails to timely file an information return, fails to include all information required to be shown on the return, or includes incorrect information on the return. The penalties apply to 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 2020 tax year, the penalty is:
(1) $50 per information return for returns filed correctly within 30 days after the due date, with a maximum penalty of $565,000 a year ($197,500 for certain small businesses);
(2) $110 per information return for returns filed more than 30 days after the due date but by August 1, with a maximum penalty of $1,696,000 a year ($565,000 for certain small businesses); and
(3) $280 per information return for returns filed after August 1 or not filed at all, with a maximum penalty of $3,392,000 a year for most businesses, but $1,500,000 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.
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 $560 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 million limitation does not apply.
A safe harbor from penalties has been established for failure to file correct information returns and failure to furnish correct payee statements for certain de minimis errors. Under the safe harbor, an error on an information return or payee statement is not required to be corrected, and no penalty is imposed, if the error relates to an incorrect dollar amount and the error differs from the correct amount by no more than $100 ($25 in the case of an error with respect to an amount of tax withheld). In Notice 2017-9, the IRS issued additional guidance on applying the de minimis error safe harbor relating to information reporting penalties.
Tax Return Questions on Whether Reportable 1099 Payments Were Made
Similar to prior years, the 2020 Forms 1065, 1120, 1120S, and 1040, Schedules C, E, and F, all contain questions asking if the taxpayer made any payments in 2020 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.
Observation: The questions first showed up in 2011 and coincided with an increase in the penalties for failing to file correct information returns and payee statements. Practitioners immediately expressed concern that their clients may not be focused enough on the ramifications of not correctly reporting Form 1099 income and on their own liability for checking these boxes. If a client reports that all Form 1099s were filed when they were not, the client may be perjuring himself or herself. If the client reports that not all Form 1099s were filed, then that's a red flag for an audit.
Practice Aid: See ¶320,690 for a client letter which explains the significance of the Form 1099 question on the various returns.
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 so that the contractor is responsible for issuing a Form 1099-NEC to that individual. 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?
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 NEC, where a Form 1099-NEC 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 NEC deduction would be limited to an amount not required to be reported on Form 1099-NEC.
What to Do If Form W-2 Is Undeliverable
A taxpayer should keep for four years any employee copies of Forms W-2 that the taxpayer tried to, but could not, deliver. However, if the undelivered Form W-2 can be produced electronically through April 15th of the fourth year after the year at issue, the taxpayer does not need to keep undeliverable employee copies. Undeliverable copies should not be sent to the SSA.
Conclusion
Practitioners should ensure that their business clients are on top of the February 1 IRS filing deadline for Forms W-2 and Forms 1099-MISC and Forms 1099-NEC. Moreover, they should also be advising their clients to have non-employee workers or contractors complete a Form W-9 where that worker or contractor may receive payments of $600 or more for the year. To the extent anyone is paid more than $600, a Form 1099-NEC should then be issued at the end of the year.
Practitioners should also document that they've had these discussions with their clients and may want to consider modifying their client engagement letters if necessary to reflect the documentation a client will need to take certain deductions on a tax 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 take the Code Sec. 199A deduction and escape the NIIT and of their responsibility for filing Forms 1099 when they are in a trade or business.
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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