The 1099 Headache

The Tax Gap is the tax the Treasury believes it loses each year due to fraud and unreported income.  From 2014 to 2016 (the most recent study available), the tax gap was $441 billion annually (and growing).   Increasing levels of unpaid tax, combined with ballooning deficits and debt, sounded the alarm - Tax dodgers must be punished.

The primary focus of increased enforcement has been on small businesses and organizations.  Why?  Collectively, they're the largest dodger, responsible for 25% of unpaid taxes in the US - $109 billion of the $441 billion tax gap.  Small businesses as a whole underreport income at a 55% rate.  Why?  Businesses and organizations fail to prepare Form 1099-NEC and 1099-MISC when required.  And when income recipients believe the IRS doesn't know they earned it, many fail to report and pay tax on the income.   

IRS Enforcement Efforts

In 2011, the IRS started implementing measures to increase Form 1099 compliance. These measures include:

1. Forcing business owners to attest to their 1099 reporting requirements, including Form 1099-NEC and Form 1099-MISC, under penalty of perjury,
2. Increasing the penalties for failing to file forms 1099 when required, and
3. Directing resources to seldom utilized enforcement measure – Backup Withholding.

[Note - If the IRS does not focus a great number of new agents on small business underreporting, they're not doing a good job collecting taxes.]

Let's discuss each measure in greater 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:

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?

The taxpayer must check the first box “yes” or “no.”  If the answer to box one is “yes,” question two must be answered.  Once the return is signed, filers have answered each question under penalty of perjury.

These questions help the IRS determine the taxpayer’s Form 1099 compliance. 

Taxpayers must understand Form 1099 reporting rules to answer each question.  Answer “yes” and IRS expects to find 1099 forms filed under the owner's social security number or employer identification number.  By answering “No,” the owner is telling the IRS that they understand the rules and made no payments requiring these forms.  

Question two is the tattle-tale question - “If yes (to question 1), did your business file, or will it file form(s) 1099?”  Answering this question tells the IRS whether or not you plan to follow the 1099 reporting requirements.  Answering “No” tells the IRS that you:

1. Understand the 1099 rules,
2. Are required to file 1099s, and
3. You decided not to follow those rules. 

In other words, you have tattled on yourself and requested a penalty assessment.

Alternatively, answer “yes” to question two, and the IRS does not find 1099s filed under your ID number, and boom!  You've volunteered for a penalty (and lied on your tax return).

[Note: Although these questions appear in Schedule E, Rental Income, rental owners are NOT required to file forms 1099s unless they claim their rentals to the level of a business.]
 

Measure Two - Increased Penalties

The penalties for not filing the required 1099 forms have doubled TWICE recently. 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.

Then 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 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 do not know and 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.  So, if the IRS 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 falsely affirms that 1099s were not required, the owner 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. 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 must remove and remit “backup withholdings” (24%-28% depending on current law) from payments made to the individual or business and submit those amounts to the IRS.  

Failure to collect and remit backup withholdings also carries a stiff penalty that most owners and their accountants do not consider.   THE PENALTY IS EXACTLY THE SAME AS THE PAYROLL TRUST FUND PENALTY.  The responsible individual can be held PERSONALLY liable for the penalty - the amount the person should have withheld: 24% to 28% of payments made to the vendor!

The Takeaway – Learn the Rules

Protect your business by learning to file your 1099 forms properly. Have your bookkeepers or accounting staff do the same.  A good place to start is Overnight Accoutant's course, Form 1099-NEC and MISC Training.
 

THANK YOU!