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 business's 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. To protect yourself and your business, you need to understand the consequences of 1099 noncompliance. Then, learn the ins-and-outs of 1099 reporting, particularly Form 1099-MISC.
This article will discuss the tax gap, why small businesses 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 vast and growing. The IRS estimated that the average gross tax gap between 2008 and 2010 was $458 billion per year. This, despite increased enforcement, is $8 billion higher than 2006’s estimate. The growing tax gap, combined with a ballooning national debt, has sounded the alarm: Small-business-tax-dodgers must be held accountable.
Small Business Target:The reason the IRS is stepping up enforcement in the small business arena is simple - the majority of tax-dodgers are small business owners. Small businesses are responsible for 50% of the nation’s $458 billion tax gap. Why? According to the General Accounting Office, it’s because they fail to prepare Form 1099-MISC when required.
Third-Party Reporting: The Great Enforcer of the U.S Tax Code.Forms like Form W-2, which reports wages, tell the IRS how much income was received by a taxpayer. The employer (the 3rd party) sends copies of the form, in this case a W2, to both the IRS and the employee. The IRS then matches the amount reported on the W2 to the employee’s tax return to ensure the wages are reported. According to a 2012 Government Accountability Office (GAO) report, 99% of income is reported by taxpayers when W2s are correctly filed.
The same report also reveals that when Form 1099-MISC (the reporting form for business income) does not occur, businesses under-report income by a substantial margin. How substantial? Approximately 56% of small business income is under-reported when owners’ do not receive the required Form(s) 1099-Misc!
The 1099-MISC Challenge: Form 1099-MISC reports rents and service payments paid to landlords, vendors, contractors, and casual labor. It performs the same function as Form W-2 by informing the IRS that the recipient received income.
The primary challenge facing the IRS, however, is small businesses failing to complete Forms 1099-MISC when required. Non-reporting is so rampant that in 2005, only 8% of small businesses submitted any 1099-MISC forms to the IRS!
New Enforcement Measures:In 2011, the IRS started implementing measures to increase 1099-MISC compliance. These measures include:
Below I will discuss these measures in detail.
Measure One - 1099 Perjury Questions:In 2011, two seemingly-innocent questions were added to all business tax returns. 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 compliance.
When answering the first question, the owner is stating that they understand the rules regarding Form 1099-MISC reporting (if not, they could not answer). If the owner marks “yes,” the IRS will expect to find Form(s) 1099-MISC Forms filed under the business EIN or the owner’s social security number.
If the owner answers “No” and there are expenses on the return that require Form(s) 1099-MISC, the taxpayer has lied on their tax return and committed perjury.
When answering the second question, the business owner is informing the IRS whether they plan to follow Form 1099-MISC reporting requirements. Answering “No” tells the IRS that the business owner:
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 form and from $100 to $250 if the taxpayer intentionally disregarded the reporting requirement.
In 2015, these penalties increased again as a revenue generator (yes, a revenue generator) in the Trade Preference Extension Act. The penalty for not filing forms 1099 jumped to $250 per form, and the Intentional Disregard penalty increased to $500 per form. The penalties are also indexed for inflation and are now even higher!
Double-Whammy Penalty:Many business owners and their accountants do not realize that these penalties can be applied separately to; 1) Not filing the forms with the IRS, and 2) Failing to provide a copy to the recipient, effectively doubling the penalty.
The penalty-trap:Remember the perjury questions mentioned earlier? If a business affirmatively states that they were required to file forms 1099 but fails to do so, they have intentionally disregarded the 1099 reporting rules. If, on the other hand, the business states that they were not required to file Form 1099, but it is later revealed that they were, the business has intentionally disregarded the 1099 reporting rules. The result in either case: 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–MISC itself. To file Form(s) 1099-MISC, the business must obtain each payee’s Taxpayer Identification Number (TIN). If a business fails to capture this TIN, it is required to remove “backup withholdings” (currently 28%) from all payments made to the individual or business and remit the funds to the IRS.
Failure to collect and remit backup withholdings has a very stiff penalty and carries the same weight as the payroll trust fund penalty, meaning a responsible individual can be held personally liable for the penalty. The penalty: the Backup Withholding that should have been withheld - 28% of payments made to the payee!
The Take-Away – Learn the Rules:Protect your business by learning to file your 1099 forms properly. If your business has been lax in collecting payee information, it may be time to implement policies to ensure each payee’s tax identification number is collected before paying them.
Quite frankly, the stakes could not be higher. Not filing your Forms 1099 can destroy your business. If you or your staff need effective and inexpensive training on form 1099-MISC we invite you to check out ourForm 1099-MISC Basics Course for Small Businessor our training course,Form 1099-MISC Basics (Training Edition).
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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