1099 More Ways to Have Tax Troubles

While most of my conversations about taxes at this point have to do with getting information about the return itself, an article in the Wall Street Journal reminded me of a change to returns this year that has big implications.  As indicated in this blog before, the IRS is falling ever deeper in love with third party reporting, and they are getting more serious about making sure it gets done.  The Service did back off on some of the more heinous aspects of making business owners reconcile the reporting they are getting from credit card companies (otherwise known as form 1099K).  Still, the reporting will be used to audit small businesses that accept payments via credit and debit cards.  What also hasn’t gone away is that if you pay for services with a credit card, and then have to issue a 1099, you need to subtract out what you put on the credit card.  Your vendor is already getting that income reported from the merchant bank that processed the transaction. Giving the IRS opportunity to double count income isn’t the best way to build business relationships.

This brings me to the matter of the 1099 Miscellaneous.

 

If you file taxes using a Schedule C, Schedule E, Form 1065 or Form 1120S there’s a question you have to answer for the first time this year asking if you did business with anyone who should have received a form 1099.  That would be anyone who you paid $600 or more to provide a service and they’re not incorporated.  Answer this question incorrectly, and if you get audited, you will face penalties, even though the form 1099 that you send has nothing to do with your gross income.  So your tax liability could be correct to the penny and you could still be in trouble with the IRS.  (Just when you thought you understood how bad this tax season was going to be!)  And the bad news doesn’t stop there.  Let me quote from the article.

In 2010 Congress stiffened the penalties on taxpayers who neglect to provide 1099 forms. The higher penalties took effect in 2011, and now the penalty for nonfiling is $100 per violation—$200, in most cases, because two forms are due, one to the IRS and one to the provider. The penalty for "intentional failure to file" is $250.

It’s a hassle to file these forms, as I know from personal experience filling them out.  However, this is a way for the government to raise more revenue without raising taxes.  That’s another way of saying it is a sure recipe for increased government action. 

Audit Triggers and a Safety Catch

While the odds of hearing from an IRS auditor are still pretty low – a little more than 1% of returns get audited – there is a growing focus by the Service on doing more to close the tax gap. (In case you don’t know, the tax gap is the difference between what is believed to be the amount of taxes that should be collected vs. the amount that is actually collected.)  One area of concentration now is trying to better target auditees, hoping to give auditors a better collection rate.  In general there are two paths for nomination to the sampling pool that audits will be pulled from.  One is to make more than a million dollars a year. The other is to have entries on your tax return that are either associated with a high incidence of fraud or outside of the normal range for that particular item.

There are mitigation strategies for all of the above.  Today’s post will focus on the areas of your tax return that can act as audit triggers.  This topic is worth a multi-part post, so we’ll get to others later. First thing to remember is that the IRS’ most effective tool for closing the tax gap is third party reporting.  Any time you participate in an activity that is going to generate an informational return (1099 is the most common) that raises the chance your info will get a second look.  This extra attention is in response to a study that suggested 60% of under-reported income comes from self-employment.  If what you put on your return doesn’t match the informational return, you are going to hear from Uncle Sam.  It’s worth noting here that self-employment income isn’t the only way to get noticed in this manner.  Your bank and investment advisors are all required to disclose information about your activities with them.

This year the IRS is all over people who can claim an earned income tax credit and people who did take a home buyer credit.  In both cases, this is an easy issue to manage.  You’re either eligible or not.  If you can prove it, you’ve got nothing to worry about.  If you don’t have good paperwork start saving to pay the money back.  Depending on how much money is involved you may want to enlist help from a lawyer or accountant if you think you messed up on either matter.

Last but not even close to least for the start of this topic is if you file a Schedule C (sole proprietor) or Schedule E (rent or royalty income) you are the IRS equivalent of a scantily clad woman walking down the street.  Regardless of your intent – you are going to get noticed.  The way to minimize annoyance from the IRS version of a catcall is possession of good records.  If you have documentation to verify what you put on the return, you’re all set.  If you don’t, my recommendation is a visit to both your accountant and your local house of worship.