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January 31 Deadline is Approaching for Forms W-2 and 1099
(Parker Tax Publishing January 2024)
As the January 31 deadline for sending Forms W-2, 1099-MISC, and 1099-NEC to employees and payees fast approaches, it is a good time for practitioners to reach out to clients and remind them of this deadline and the penalties that can result when the deadline is missed. More taxpayers will be required to file information electronically starting this year as a result of the e-filing regulations finalized in 2023. In addition, 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 1099 and Form 1099-NEC.
Staying on top of the January 31 deadline is critical because substantial penalties can be imposed if taxpayers: (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. While taxpayers may want to escape liability for filing these forms by claiming payments were not made in the course of a trade or business, that position can hurt them if (1) they want to avail themselves of the Code Sec. 199A deduction, which is only available to persons engaged in 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.
Practice Tip: Payments made with a credit card and certain other types of payments, including third-party network transactions, must be reported on Form 1099-K, Payment Card and Third-Party Network Transactions, by the payment settlement entity and are not subject to reporting on Forms 1099-MISC or 1099-NEC.
Filing Deadlines for Forms W-2 and Forms 1099-NEC and 1099-MISC
Taxpayers that are required to report 2023 payments of nonemployee compensation (NEC) must file Forms 1099-NEC with the IRS and with recipients on or before January 31, 2024, using either paper or electronic filing procedures. Taxpayers that are reporting payments other than NEC must file Form 1099-MISC with recipients by January 31 and with the IRS by February 28, 2024, if filing on paper, or April 1, 2024, 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 January 31 deadline and meet one of the criteria listed on Form 8809, Application for Extension of Time to File Information Returns. The request for an extension of time to file Form 1099-NEC or Form W-2 must be filed on the paper version of Form 8809. One 30-day extension of time 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 the taxpayer has withheld any federal income tax (reported 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 2023, 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 a limited liability company (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, 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.
The following payments do not need to be reported on Form 1099-MISC:
(1) generally, payments to a corporation (including an 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);
(9) Code Sec. 409A deferrals (box 12); or
(10) nonqualified deferred compensation (box 14).
Observation: 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 Forms 1099, but the characterization of not being in a trade or business can also hurt certain taxpayers. Classifying 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. Code Sec. 199A allows a domestic business operated as a sole proprietorship, or operated through a partnership, S corporation, trust, or estate, to take a deduction of up to 20 percent of income if certain requirements are met; however, the deduction is only available to a qualified trade or business.
Penalties for Failing to File Correct and Timely Forms 1099
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 per return and 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 2023 tax year, the penalty is:
(1) $60 per information return for returns filed correctly within 30 days after the due date, with a maximum penalty of $664,500 a year ($232,500 for certain small businesses);
(2) $130 per information return for returns filed more than 30 days after the due date but by August 1, with a maximum penalty of $1,993,500 a year ($664,500 for certain small businesses); and
(3) $330 per information return for returns filed after August 1 or not filed at all, with a maximum penalty of $3,987,000 a year for most businesses, but $1,329,000 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 filing more than 10 information returns of any type must file all information returns electronically. 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. The penalty for failing to timely file a return electronically applies separately to original returns and corrected returns.
Observation: The prior threshold for electronic filing was 250 returns. However, the threshold was reduced from 250 returns to 10 returns, effective for returns required to be filed on or after January 1, 2024, by the Taxpayer First Act of 2019 and the final regulations issued in February 2023 (T.D. 9972).
Practice Tip: The IRS provides a free online portal, the Information Returns Intake System (IRIS), for businesses to file Form 1099 series information returns electronically. Taxpayers must apply for a transmitter control code (TCC) in order to use the IRIS system. In addition, the Social Security Administration operates a free W-2 Online website where employers can electronically report their employees' wages for 2023. The employer must register for "Business Services Online" to use W-2 Online. Employers may register for this service at www.ssa.gov/employer/firstFilers.htm.
The penalties discussed above also apply 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 failing to include the correct information on a return does not apply to a de minimis number of information returns 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 $660 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 applies 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). Final regulations issued in T.D. 9984 in December 2023 implement the de minimis error safe harbor relating to information reporting penalties.
Civil Damages for Fraudulent Filing of Information Returns
In addition to penalties originating from the IRS, Code Sec. 7434 provides that a person may bring a civil action for damages against any person who willfully files a fraudulent information return with respect to the person filing for damages. If found liable, the filer of the fraudulent return is liable for damages equal to the greater of $5,000 or the sum of (1) any actual damages resulting from the filing of the fraudulent return, (2) the costs of the action, and (3) reasonable attorney's fees.
Workers have tried to recover damages under Code Sec. 7434 for issuing Forms 1099 rather than W-2s, but courts have generally rejected these claims and held that the misclassification of a worker as an independent contractor does not give rise to a claim under Code Sec. 7434. For instance, in Sokoloff v. Bio World Merchandising, Inc., 2022 PTC 347 (M.D. Ga. 2022), a district court held that a worker could not bring a cause of action against his former employer under Code Sec. 7434 for intentionally filing Forms 1099s instead of W-2s for the period that the business treated him as an independent contractor, but for which he claimed he was an employee. The district court held that Code Sec. 7434 only creates a cause of action if the information return is false or misleading as to the payment amounts reflected on the return.
Tax Return Questions on Whether Reportable 1099 Payments Were Made
Similar to prior years, the 2023 Forms 1065, 1120, 1120S, and 1040, Schedules C, E, and F, all contain questions asking if the taxpayer made any payments in 2023 that would require the taxpayer to file Form(s) 1099. If the answer is "yes," then the taxpayer must divulge whether the required Forms 1099 have been, or will be, filed.
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? To date, there is no guidance or court cases addressing these issues.
Can IRS Limit Deductions to $600 Where No Form 1099 Is Filed?
Some practitioners have questioned whether or not the IRS can limit a taxpayer's compensation deduction to $599, the cutoff for not reporting NEC, where a Form 1099-NEC is not filed for a particular worker. 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 to such employee. 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 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, Request for Taxpayer Identification Number and Certification, 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 in order to take certain deductions on a tax return. Similarly, practitioners may want to warn their clients about the trade-offs for claiming they are engaged in a trade or business so they can take a Code Sec. 199A deduction versus escaping the NIIT by claiming to not be 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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