The income tax compliance season begins on January 31st each year when W-2’s and 1099 (“Information Returns”) are issued. With these returns in hand, 145 million filers can begin to prepare their individual returns and claim their refunds or figure out how much they will owe the IRS. Approximately 2.9 billion Information Returns are expected to be filed in 2012. The largest number of these returns (1.6 billion) relates to broker reporting (Form 1099-B). (Only 222 million are W-2’s.)
Last year, the IRS Commissioner observed that more than 96 percent of taxpayers receive at least one type of Information Return. A small fraction of the population skews the average number of Information Returns per taxpayer to about 10, even though more than 50 percent of taxpayers receive less than four Information Returns. Payer concentration is also an eye-opener. Fifty-six payers constitute 50 percent of the overall volume of Information Returns.
A summary of the common federal information returns can be found on the IRS web page. It is important to consider the scope of the various returns and filing thresholds as well as their due dates. Instructions for most Information Returns can also be found on the Internet.
Information Reporting Facilitates Tax Compliance
Most Information Returns provide filers (and the IRS) with a summary of their income for the year and any taxes withheld. It is important to review these returns carefully to verify their accuracy. You should make sure that you have received all Information Returns before finalizing your return. For the more than 4.3 million information-matching notice discrepancy audits, the average return on investment for the IRS is $1,670 per return, with little involvement by IRS personnel. Not reporting information correctly or leaving it off your return entirely can also invite more comprehensive audits by the Service. The IRS mail audit program, responsible for 78 percent of all IRS audits in 2010, averages almost $6,600 in additional taxes owed per audit.
According to an IRS study reviewed by Bruce Bartlett, Americans owed $450 billion more in federal taxes in 2006 than they paid, an increase of $105 billion over 2001. Noncompliance primarily takes the form of unreported income rather than taking unjustified deductions and exemptions. Information Reporting and withholding are the IRS’s principle lines of defense against tax cheating. Noncompliance is lowest in areas where there is substantial reporting requirements and withholding. One solution to the tax gap is to increase reporting and withholding requirements. However, according to Bartlett, previous efforts by Congress to beef up these requirements have been met with huge political resistance. People don’t like the intrusion into their privacy and businesses don’t like the cost of reporting.
What’s New This Year?
Form 1099-K is an attempt to put an end to the untaxed, underground/untaxed economy for goods and services paid by credit card or third party merchants, like e-bay.
Form 1099-K is required when a payment card (such as a credit card or gift card) is accepted as payment or any transaction that is settled through a third party payment network like PayPal. It will also be sent to professionals like lawyers and architects who accept online or credit card payments for services, eBay merchants, and other small businesses who accept such payments.
The 1099-K will include sales tax and shipping charges, for example, and may not accurately reflect refunds. When you receive a 1099-MISC, be sure it includes only payments you received by cash or check. You don’t want the income reported twice to the IRS, so check your records carefully.
Taxpayers receiving Form 1099-B for brokerage activity should anticipate a more complex form. The new 1099-B form will now include details on cost basis and holding periods, as well as acquisition date information and disallowed losses from wash sales.
Unexpected Information Returns
One Information Return that comes as an unwelcome surprise is Form 1099-C for "cancellation of debt." The IRS considers forgiven or canceled debt as taxable income. Creditors and debt collectors who agree to accept at least $600 less than the original balance are required to disclose debt discharges to the IRS and debtors. The number of 1099-C cancellation of debt forms filed have more than tripled between 2003 and 2010, and the IRS expects to get 6.4 million debt forgiveness forms in 2012. A major part of the spike may be due to the rise in mortgage foreclosures, but a significant portion of it is also attributed to credit card debt. (Form 1099-A, Acquisition or Abandonment of Secured Property, is required for a borrower that surrenders or abandons an interest in property that is security for the debt.)
Form W-2G, Certain Gambling Winnings, is used to report gambling winnings and any federal income tax withheld. Approximately 11.5 million of these forms are expected to be filed in 2012. The requirements for reporting and withholding depend on the type of gambling and the amount of the gambling winnings. Prizes, though, are reported on Form 1099-MISC.
Form 1099-G (Certain Government Payments) is most likely a state generated form. The most common reasons for it would be unemployment compensation, a lottery win, or a state tax refund you received last year. If it's unemployment, then you claim it on your federal return as ordinary income. A lottery win would be claimed as "other income."
Do You Need to Prepare Information Returns?
The Internal Revenue Service (IRS) requires businesses (including not-for-profit organizations) to issue a 1099 to any individual or unincorporated business paid in excess of $600 per calendar year for services rendered. (Unincorporated businesses include partnerships, limited liability companies treated as a partnership and sole proprietorships.) Reporting is required whether these payments are spread out over the course of the year or are paid in one lump sum payment. This form is generally not required to be issued to incorporated businesses. The only exception is when payments are made to incorporated law firms and certain medical and health care providers.
Businesses will need to prepare a Form 1099-MISC for domestic persons, vendors, subcontractors, independent contractors and others for such things as services (including parts and materials) in excess of $600 in a year.
Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee and report this information on W-2’s. The rules are different for “independent contractors.” Independent Contractors working for you may need to be provided a Form 1099-MISC if you paid them more than $600 in a year. Generally you don’t have to withhold or pay any taxes on these payments.
Payment of interest, rents, royalties, and most passive-type income paid by a business is reported on 1099’s. Payments of most passive-type income to foreign individuals or businesses, however, must be reported on Form 1042-S, and withholding of 30-percent may be required unless the withholding rate is reduced by an income tax treaty. (Form 1042-S must be filed by March 15th.)
Vendors, contractors and other payment recipients should submit a Form W-9 to the payer. The W-9 will include the payee’s legal name, address and taxpayer identification number (TIN) for the vendor, which is the information you will need when preparing any 1099 forms. (Foreign payees should use the appropriate Form W-8 instead.) If this information is not provided, backup withholding of 30-percent may be required for interest, dividends, broker and barter exchange transactions, rents, royalties, nonemployee pay, and certain payments from fishing boat operators. (A nonresident alien or a foreign entity is not subject to backup withholding, if a Form W-8 is provided.)
A person (including a financial institution, a governmental unit and a cooperative housing corporation) that is engaged in a trade or business and, in the course of such trade or business, received at least $600 of mortgage interest from a borrower (including certain points) on any one mortgage in the calendar year must furnish Form 1098.
Due to intense lobbying, Congress relaxed two information reporting requirements. President Obama signed into law the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011, which repeals both the expanded Form 1099 information reporting for corporate suppliers and also the 1099 reporting requirements imposed on taxpayers who receive causal or passive rental income.
What is Ahead?
Can the information return system ease taxpayers’ compliance burden? IRS Commissioner Schulman has suggested a new vision for compliance: using electronic information reporting to populate individuals’ returns. Under his vision, the IRS would get all information returns from third parties (W2s, 1099s, etc) before individual taxpayers filed their returns. Taxpayers or their professional return preparers could then access that information, via the Web, and download it into their returns, using commercial tax software. Taxpayers would then add any self-reported and supplemental information to their returns and electronically file their returns. Core third-party information would be embedded into the IRS’ pre-screening filters and the filters would reject any return that did not match up with IRS records. It is a vision easier articulated than executed -- don’t expect dramatic changes in the next several years.
by Barbara Ashorn, CPA
MFR, PC
bashorn@mfrpc.com | 
