-By Donovan Thiessen, CPA
The IRS has increased efforts in recent years to close the estimated $300 billion tax gap (amount taxpayers owed versus the amount received). One of the most popular ways is through its Automated Underreporter program. Information returns such as W-2s and 1099s filed by third parties (employers, banks and brokers) are being matched to income reported by taxpayers on their income tax returns. If a discrepancy exists, the Service issues a Notice letter and requires the taxpayer to prove their position. Many small business owners are unaware of the 1099 filing requirements and the increased penalties for noncompliance. By the end of this article you will learn how to better navigate this part of your business and avoid noncompliance.
In 2011 two seemingly innocent questions appeared on income tax returns for individuals, trusts, partnerships and corporations:
1. Did your business make any payments that would require filing form(s) 1099; and
2. If yes, did your business file or will it file form(s) 1099?
These questions and answers serve as a taxpayer’s attestation, under penalties of perjury, that they are aware of the filing requirements. It is critical that this question is answered correctly.
Generally, if you make aggregate payments of at least $600 in the course of your trade or business to a non-employee, you may need to file a 1099-MISC to this person or business. A few examples that would likely trigger a 1099 to be issued: rent expenses, temporary office assistance, payments to attorneys, payments for services performed by IT, landscaping, repairman, consultants, bookkeepers (the list is more detailed in the 1099 instructions).
In order to issue a 1099-MISC, each business must obtain the Taxpayer Identification Number (TIN or EIN employer identification number) from their service providers. Generally, this is done by sending Form W-9 to the individual or business. The information on the W-9 will determine if a 1099 should be issued to the vendor. If the vendor fails to remit their W-9, the payor is generally required to send backup withholding to the IRS for 28% of the payment. Failure to withhold and remit backup withholding in this case can carry a penalty of 28% – equal to the amount that should have been withheld. For these reasons it is prudent to obtain a completed W-9 before you send the first payment to a new vendor.
The penalties for filing late (for small businesses) can be as high as $260 per return, up to a max fine of $1,072,500. The “intentional disregard” penalty can be as high as $530 per return with no maximum limitation. For instance, if you were four months late filing twelve 1099s, you could be liable for a $1,200 penalty ($100 per return in this example).
The filing due date is January 31, 2019, for payments made during the 2018 tax year. Taxpayers can typically prepare 1099s in their accounting software (Quickbooks, Xero, Wave) or they can hire an accountant or payroll company to prepare and file these returns.
When you are ready to issue a check to a vendor, you should already have their completed W-9. Check your accounting software to identify this vendor as a potential 1099 recipient. File the W-9 in a permanent file as you would with other important tax documents. In December, you should run a report for possible 1099s to be issued. Generally, this report is populated with the vendors you’ve tagged as 1099 recipients. There may be additional report details such as which types of expense accounts cause payments to be flagged as possibly needing a 1099. At this point you should review if you are missing any W-9s (you shouldn’t because your new policy says not to issue a check without a W-9!).
The 1099 Instructions includes a paragraph regarding Form 1099-K. It says:
“Payments made with a credit card or payment card and certain other types of payments including third-party network transactions, must be reported on Form 1099-K by the payment settlement entity under section 6050W and are not subject to reporting on Form 1099-MISC. See the separate instructions for Form 1099-K.”
This means that if possible, you should pay vendors with a business credit card. The report for possible 1099 recipients (referred to as the 1099 Wizard in Quickbooks) that I referenced earlier will also include a column that segregates payments made with a credit card and excludes them from amounts to be included on the 1099. You would greatly improve the efficiency of this process if you adjust your payment policy to favor business credit cards. The theory: if you pay a vendor with a credit card, then he must have a merchant services account set so he can receive these payments. On the vendor’s side, the merchant service account sends him an annual aggregate receipts report. For income tax purposes, the vendor must report at least his aggregate receipt total for his gross business income, or it could result in a mismatch with the Automated Underreporter program. Therefore, a matching mechanism is in place for payments made and received with a business credit card and does not need to be included with the 1099-MISC filing.
Generally, payments made to a corporation are exempt and do not have to be reported on Form 1099-MISC. You can identify the payee type on their completed W-9. There is an exception to this exception however. Payments to corporations for legal services must be reported on a 1099.
Filing 1099s, and their related best practices is often overlooked or dealt with hastily at the deadline. You can avoid costs related to noncompliance by installing or reviewing your internal controls. Additionally, be sure to collect the 1099-MISC forms you receive as a business owner and make sure they agree to the gross income in your books. Disregarding the law can be costly not just for penalties but for additional tax and legal representation. If you are in need of reviewing your system for 2018, you only need to look back 6 months to review your payment activity. That is your starting point.
Please note: the IRS 1099 instructions provide additional reporting details that are impractical to cover in this article. The information presented here is general in nature, if you have a question about your tax situation please refer to the IRS 1099 instructions and contact a tax advisor.
Donovan Thiessen, CPA has worked for Gerety & Associates, CPAs in Las Vegas, Nevada for 10 years, focusing on trust and estate, and individual and business income taxation. The firm has substantial experience in estate planning and can handle complex transactions. You may reach Donovan at firstname.lastname@example.org and 702.933.2213.