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January 31 Deadline Looms for Forms W-2 and 1099-MISC; Strategies for Claiming 199A Deduction May Trigger Filing Requirements
(Parker Tax Publishing January 2019)
The possibility that many IRS employees might not be around during the partial government shutdown to process Forms W-2 and Forms 1099-MISC has no impact on the January 31 deadline for filing these forms. Although filing requirements for those forms are unchanged for 2018, for some taxpayers, strategies to avoid the net investment income tax (NIIT) or to claim eligibility for the Code Sec. 199A deduction may trigger the 1099 filing requirements.
Practice Aid: See ¶320,690 for a client letter which explains the requirement to file Form 1099s.
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.
Filing Deadlines for Forms W-2 and Forms 1099-MISC
The 2018 Forms W-2 must be filed with the Social Security Administration (SSA) by January 31, 2019. Form 1099-MISC must be filed with the IRS by January 31 if non-employee compensation (NEC) is being reported on the form. If a Form 1099-MISC is not reporting NEC and is filed on paper, the filing deadline is February 28, 2019. If the Form 1099-MISC is not reporting NEC and is filed electronically, the deadline is March 31, 2019.
Extensions of time to file Form W-2 may be requested. One 30-day extension to file Form W-2 may be requested by submitting a complete application on Form 8809, Application for Extension of Time to File Information Returns. Form 8809 must include a detailed explanation of why the additional time is needed and be signed under penalties of perjury. Extensions are granted only in extraordinary circumstances or catastrophe.
Form 1099-MISC
Generally, any person, including a corporation, partnership, individual, estate, and trust that 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 taxpayer's trade or business. Thus, personal payments are not reportable. A payer is engaged in a trade or business if it operates for gain or profit. 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.
Observation: The determination of whether a taxpayer is engaged in a trade or business, and thus liable for filing Forms 1099-MISC, is important for a couple reasons. While taxpayers may want to escape liability for filing Forms 1099-MISC 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.
The type of reportable transaction determines the 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 NEC. In general, a payer must file Form 1099-MISC 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.
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 NIIT. Taxpayers taking the position that their activity is not subject to NIIT because it rises to the level of a trade or business, need to be aware of 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 won't be 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 2018 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 $545,500 a year ($191,000 for certain small businesses);
(2) $100 per information return for returns filed more than 30 days after the due date but by August 1, with a maximum penalty of $1,637,500 a year ($545,500 for certain small businesses); and
(3) $270 per information return for returns filed after August 1 or not filed at all, with a maximum penalty of $3,275,500 a year for most businesses, but $1,091,500 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 $530 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 2018 Forms 1065, 1120, 1120S, and 1040, Schedules C, E, and F, all contain questions asking if the taxpayer made any payments in 2018 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-MISC 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-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 NEC deduction would be limited to an amount not required to be reported on Form 1099-MISC.
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 January 31 filing deadline for Forms W-2 and Forms 1099-MISC that include 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-MISC 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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