TAXING TIMES, JUNE 2015 EDITION
By Rick Torkelson, CPA and principal of Torkelson & Associates, LLP in Petaluma, CA
Various issues surrounding 1099’s come up all the time in the tax business so they are worthy of some discussion. In my opinion, the 1099 is the primary reason why there are so much fewer and less comprehensive audits than in the past.
What is the Purpose of Forms 1099?
The purpose of the form 1099 is to put you on the IRS radar. If a 1099 could talk, it would say “Hey! – This guy got paid taxable income and should file a tax return!”
The IRS generates huge revenue – inexpensively – because of the 1099. When a 1099 is issued and filed with the IRS, the IRS computer matches the gross income reported on a tax return to the total forms 1099 filed for that individual. If the individual reports the same or more income than on the 1099’s, the computer moves on. If the individual reports less income than reported on all the 1099’s (or if the individual doesn’t file a tax return at all) it sends the taxpayer a letter – you’re on the radar!
Who is Required to File Forms 1099?
There are scores of different 1099s. For this blog, I’m only going to focus on the dreaded “1099 Misc” as required for Non-Employee Compensation (NEC). This is when a business owner (including taxpayers who own even one rental unit) pays an individual $600 or more for any labor or service. This means you hire your friend for $1,000 to help you build a fence for your rental unit – you are required to get his social security number and issue him a form 1099. You do not have to issue a 1099 to a corporation.
What If I Don’t File Required Forms 1099?
The due date for required forms 1099 is February 28 of the following year – 2/28/15 for the year 2014. The penalty is $100 per 1099 that you failed to file. Penalties are somewhat less if you file before August, but after the February due date. Also, penalties are not assessed for “inconsequential errors” – you issued a 1099, and the amount was close, but incorrect.
How Would I Get Caught?
Basically, you’d get caught by being unlucky enough to get an audit. When any business is under audit, the IRS always asks for the filed forms 1099. If no forms 1099 were filed and the IRS auditor determines that there should have been, they ask you to file them now – even if a year or more late. Things can get ugly here. The taxpayer is at times in the awkward position of requesting social security numbers from people who often didn’t pay tax on the income. If the taxpayer can’t come with the ID number (or the service provider refuses to give it), the IRS can either deny the deduction for the service (you pay taxes on the income instead of the service provider) or they can assess you 28% of the income that you were required to withhold when a service provider won’t give you their ID. When you add interest and penalties, this can be expensive.
One more thing – Both the Business Schedule C and the Rental Schedule E have the following two questions: “Did you make any payments in [year] that would require you to file Form(s) 1099?” and “If ‘Yes,’ did you or will you file required Forms 1099?” – This forces the taxpayer to either file the required Form(s) 1099 or lie on the return – never recommended!
What to Do
Before a laborer or service provider has begun their work, hand them a Form W-9: Request for Taxpayer Identification Number. This is a very simple form that can be easily downloaded from the IRS website. It does two things – It asks for their name, address and ID number and it puts them on notice that they will be issued a form 1099.
If you do not issue required forms 1099 and your business gets big enough, eventually, you are betting your business that you will not be caught – and the IRS is getting better at catching you.
Estimate #2 is due June 15th. Remember, estimates are appropriately called estimates. If income is down, you can lower your estimate. If income is up, consider increasing your estimate (or save you money for next April 15th).