Fact or Fiction: 5 Form 1099 Myths Debunked
You may think Forms 1099 aren’t a big deal. Presumably your company sends them as matter of course to any independent contractor who does more than $600 worth of work for you. But the fact is, if you don’t use them correctly, the consequences can be staggering. Make sure you get your facts straight and don’t buy into the following misperceptions:
Myth 1: You don’t need to include expense reimbursements on Form 1099-MISC.
An employer has two options when deciding how to treat the reporting of expense reimbursements for independent contractors. For one, if the employer has a reimbursement program in place for its employees that qualifies as an accountable plan, the employer can require independent contractors to follow the same procedure.
An accountable plan is generally one that requires documentation to demonstrate that expenses are business related and that amounts in excess of substantiated expenses are not reimbursed. If it fills that bill, the employer can consider the expense reimbursements to its employees as working condition fringe benefits and not taxable income. And so that same employer, if it requires independent contractors to follow the same procedures for reimbursement, does not have to include the reimbursements in the independent contractors’ Form 1099-MISC. However, if the company chooses to not include these amounts, it will retain liability for doing so and must retain documentation supporting the underlying expenses.
Conversely, if the employer either does not have an accountable plan or does not require independent contractors to provide proof of their expenses, via receipts or other documentation, the employer should include those reimbursement amounts in the reported compensation on Form 1099-MISC. It will then be up to the independent contractors to deduct business-related expenses on their tax return and maintain records that support those claims.
Companies may find they are better off leaving the responsibility up to their independent contractors, suggests Andrew Poulos, principal at Poulos Accounting and Consulting. “If an individual is truly an independent contractor, it is advisable for the company to not reimburse … for expenses,” he says. “The independent contractor should factor those costs into the project fee. However, from an audit-liability reduction standpoint, whatever is paid to the independent contractor, whether in the form of compensation or expense reimbursement, should be reported on the Form 1099-MISC.”
Myth 2: Forms 1099 need to be issued to payees and the IRS at the same time.
Another misconception, according to Gregory Zbylut, who runs a law practice focused on tax and business transaction issues, is when Forms 1099 must be issued. The deadline for providing the Form 1099-MISC to recipients is no later than January 31. A copy must also be provided to the IRS no later than February 28 if a paper copy is submitted. The deadline is moved to April 15 if done via electronic filing.
“Often, issuers send all the forms out when they send the IRS its copy, but that is not proper, and could subject the business to fines,” says Zbylut.
Myth 3: If we don’t issue a Form 1099, it’s no big deal.
Michael Trabold, director of compliance at payroll company Paychex, observes that a lot of companies do not fully recognize the penalties they could face if they don’t follow the rules for Form 1099 or how much time they truly have to make corrections. “There are penalties for not sending both the information return copy to the IRS and the payee copy to the contractor,” he says. “For both, the penalty amount escalates the longer the non-filing persists, up to a maximum of $100 per instance (or $200 if a company fails to file both).”
Those mistakes could add up: The taxman can impose the maximum penalty if the failure to file extends beyond Aug. 1 — as much as $1.5 million per year for payee copies and an additional $1.5 million for IRS copies.
Moreover, if the Form 1099 is filed within 30 days of the due date, the penalty is $30 per return, up to a maximum penalty of $250,000 per year. If the Form 1099 is filed more than 30 days after the due date, but before Aug. 1, the penalty is $60 per return, up to a maximum of $500,000 per year. Again, these amounts are per type of information statement (payee versus IRS).
To be sure, the IRS could reduce the penalty if a company can show reasonable cause for its compliance failure. But it also can impose penalties against companies for other mishaps – such as filing a Form 1099 with a missing or incorrect Taxpayer Identification Number (TIN) or other data.
Do the penalties sound like too much? Small businesses face lower annual maximums. Those companies that, in general, have average annual gross receipts for the three most recent tax years of $5 million or less, would have to pay, for example, no more than $500,000 for missing the Aug. 1 deadline.
Myth 4: I don’t have to issue a Form 1099 when I settle a lawsuit or claim for damages.
Zbylut says this is false and provides the following example: Assume A sues B for damages. After some litigation, B and A agree to settle for $30,000, with B to pay A. A has an agreement with his attorney that the attorney will get one-third of the damages (or $10,000).
B’s counsel should request A’s attorney to complete Form W-9, Request for TIN. When B sends the check, it should be “Payable to A and A’s attorney, $30,000.” B should send A’s attorney a Form 1099-MISC with Box 14 completed (for the full amount of $30,000).
If A is unincorporated, A’s attorney should request that A complete Form W-9. A’s attorney should then send all appropriate forms to A. What forms get sent will depend on the damages. If damages include past rent, then Form 1099-MISC, with Box 1 completed is appropriate. If the damages were for wages, a Form W-2 should be used. (Keep in mind these scenarios are very fact specific and should be run by a tax adviser.)
What about B and his attorney? B should also send a 1099-MISC to his attorney for whatever was paid in Box 7. Any witnesses, vendors, and so on who were paid more than $600 should also get 1099-MISC with Box 7 completed.
Myth 5: I don’t have to issue a Form 1099 to vendors.
If your company uses vendors, you are required to issue a Form 1099-MISC to those that have been paid $600 or more, but only if they are not corporations (or are elected to be taxed as a corporation). This can make things complicated, but it’s best to get your documentation in order.
According to Zbylut, the business should inquire in writing as to whether or not the vendor is incorporated or send the vendor a Form W-9. For vendors that are not corporations, for example sole proprietors and partnerships, the business should issue a 1099-MISC. If the vendor is incorporated, no 1099-MISC is required.
Kandice Bridges is a freelance writer specializing in issues related to business, legal, tax, retirement, executive compensation, and women in executive leadership. She can be found at www.kandicebridges.com.