Over the past few years, the U.S. Treasury Department has taken aggressive steps to increase Form 1099 compliance by small businesses. These steps stem from the Treasury Department’s growing frustration with small businesses’ contribution to the Tax Gap: The difference between taxes owed by taxpayers and the amount reported on their tax returns.
Form 1099 compliance is no longer a joke or an afterthought. Noncompliance can now destroy a small business. If you want to protect yourself and your business, it’s time to learn the ins-and-outs of 1099 reporting, particularly Form 1099-NEC (which now reports nonemployee compensation) and Form 1099-MISC. We created the Form 1099-NEC and 1099-MISC Training Course for just that reason – to keep your business and clients in compliance.
In this article, we’ll share the reason small businesses and organizations are in the IRS crosshairs, and the steps - including LARGE penalties – the Treasury has taken to increase compliance.
The Tax Gap: The Tax Gap is the amount of tax the Treasury believes it loses each year due to fraud and unreported income. From 2011 and 2013 (most recent estimate available), the Tax Gap averaged $441 billion per year. Continually increasing levels of unreported and under-reported income, combined ballooning deficits and national debt, sounded the alarm: Tax-dodgers must be held accountable.
Small Business Target: The IRS has been stepping up enforcement on small businesses and organizations. Why? The answer is simple. They compromise the largest segment of tax-dodgers and are responsible for $109 billion of the nation’s $441 billion tax gap with a misreporting (underreporting) rate of 55%. Why? Business and organization’s failure to prepare Form 1099-NEC and 1099-MISC when required.
Third-Party Reporting: The Great Enforcer of the U.S. Tax Code. Information returns like Form W-2 tell the IRS how much income was received by a taxpayer. The employer completes the W2 and sends copies to both the IRS and the employee. Each W2 informs the payee of his earnings and permits the IRS to match it to the employee’s tax return, ensuring the income’s reporting. According to a 2012 Government Accountability Office (GAO) report, taxpayers report 99% of wages and salaries because of W2s.
The same report also reveals that when self-employment (1099-NEC) and rental income (Form 1099-MISC) does not occur, taxpayers under-report their income – and not by a little. Approximately 56% of small business income is under-reported when owners’ do not receive the required 1099s, especially 1099-NEC!
The 1099-NEC & Form 1099-MISC Challenge: Form 1099-NEC and 1099-MISC service and rent payments to landlords, vendors, contractors, and casual labor. They perform the same function as Form W-2 by informing the IRS that the recipient received income that should appear on their tax return.
The primary challenge facing the IRS, however, is small businesses failing to complete Forms 1099 forms when required. Non-reporting is so rampant that in 2005, only 8% of small enterprises, many of which had substantial deductions for contract labor, submitted any 1099-MISC forms to the IRS!
New Enforcement Measures: In 2011, the IRS started implementing measures to increase Form 1099 compliance. These measures include:
Below I will discuss these measures in detail.
Measure One - 1099 Perjury Questions
In 2011, the IRS added two seemingly-innocent questions to all business tax returns the same year. These questions are:
The taxpayer is then required to check the box “yes” or “no,” a response made under penalty of perjury when the tax return is signed.
Why is this Significant? How a business answers these questions helps the IRS determine the taxpayer’s Form 1099 compliance.
To answer the first question, the owner must understand the rules regarding Form 1099-NEC and 1099-MISC reporting. If they mark “yes,” the IRS will expect to find 1099-NEC and/or 1099-MISC forms filed by the business.
If the owner answers “No,” and there are expenses on the return that would require these forms, they have lied on their tax return and committed perjury.
When answering the second question, “If yes, did your business file, or will it file form(s) 1099?” you are informing the IRS whether you plan to follow 1099 reporting requirements. Answering “No,” tells the IRS that you:
In other words, you just tattled on yourself and requested a penalty assessment.
Measure Two - Increased Penalties
The penalties for not filing the required 1099 forms have doubled TWICE in recent years. First, The Small Business Jobs and Credit Act of 2010 increased the penalty for not filing forms 1099 from $50 to $100 per 1099 - $100 to $250 if the taxpayer intentionally disregards the requirements.
In 2015, Congress increased these penalties again, this time as a revenue generator (yes, a revenue generator). The Trade Preference Extension Act bumped the non-filing fine up to $250 per 1099, and the Intentional Disregard Penalty to $500. The act also indexed the penalties for inflation! By 2020, these fines had risen to $270 and $550 for each 1099.
Penalty Double-Whammy: So, ready for a super-scary fact – a fact many owners and accountants have not experienced, …yet? Information return penalties can be applied separately to; 1) Not filing the form with the IRS, and 2) Failing to provide a copy to the recipient.
The result: When the IRS so-chooses, it can DOUBLE THE FINES listed above!
The Intentional Disregard Trap: Remember the perjury questions mentioned earlier? When a business owner affirmatively states they were required to file 1099 forms but fails to do so, they have intentionally disregarded the 1099 reporting rules. If, on the other hand, the owner affirms that 1099s were not required when they were, the business has deliberately ignored the rules. The result in either case: Evidence they lied when signing their tax returns and a potential penalty of $1,000+ per 1099!
Measure Three - Back-Up Withholding Enforcement
Arguably, the most potent weapon in the 1099-enforcement arsenal has little to do with Form 1099-NEC or 1099–MISC themselves. Before a business can file any information returns, it must obtain each payee’s Taxpayer Identification Number (TIN). When it lacks a payee’s TIN, it is required to remove and remit “backup withholdings” (24%-28% depending on current law) from payments made to the individual or business.
Failure to collect and remit backup withholdings carries a very stiff penalty. Worse yet, it is a penalty that carries the same weight as that applied to payroll trust fund payments. The responsible individual can be held PERSONALLY liable for the penalty. What is the fine? The amount the person should have withheld: 24% to 28% of all payments made!
The Take-Away – Learn the Rules: Protect your business by learning to file your 1099 forms properly. Have your bookkeepers or accounting staff do the same.
As you can see, the stakes could not be higher. Not filing 1099 forms can destroy your business or organization. To avoid such consequences, check out our Form 1099-NEC and 1099-MISC Training Course. The course helps companies and organizations report their most common reportable payments - nonemployee compensation, rents, and payments to attorneys & health care providers. It also dovetails perfectly with our Employee vs. Independent Contractor Course.
All courses and articles are for informational purposes only and do not constitute tax advice. Taxes are complicated - do not act on course information without consulting a professional. Always refer to treasury regulation before making any tax decision. Read the full disclaimer.
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