New Form 1099 Compliance Question on 2011 Tax Return Forms

Over the years, Congress has dramatically increased the penalties for not filing Forms 1099 (or filing incorrect 1099 forms) when required.  At the same time, Congress and the IRS have increased the complexities of completing these forms.  Now, as a "coup de grace," the IRS has added a question to each of the business entity tax returns, and also to individual sole proprietor business forms (e.g. Schedules C and F), where you must respond to whether you made payments during 2011 for which Forms 1099 were required to be completed, and if so, did you file ALL of the required forms?  Since tax returns must be signed under penalties of perjury, the IRS has "gotcha" if you answer favorably but didn't fully comply.

The IRS is trying to close the "tax gap" by catching people who don't pay income tax on all of their earnings.  Using IRS computers to match income reported by payers to the tax returns of payees is an efficient way for the IRS to audit income.  However, the burdens on business have been greatly increased by forcing businesses to report the amount of money paid to other businesses and people.  I counted 30 different types of information reporting forms in the 2011 Form 1099 instructions!  There are even more information reporting forms not included in the 1099 family, such as Schedule K-1's, Form 8594 for business asset purchases, and Form 8937 for corporate distributions affecting stock basis.  Companies must install adequate software systems to keep track of the information that must be reported in order to avoid significant penalties that in some cases could put them out of business.

Forms 1099 must generally be provided to payees by January 31, 2012.  A 30-day extension may be requested by sending a letter to the IRS.

Forms 1099 must generally be provided to the IRS by February 28, 2012.  Electronic filing is required if 250 or more copies of Form 1099 must be completed.  The 250 test applies separately to each type of Form 1099.  The due date for sending electronic information to the IRS is April 2, 2012.  However, advance approval to file electronically must first be received by filing Form 4419 at least 30 days before the April 2nd due date.  An automatic 30-day extension can be received by filing Form 8809.  In addition, a one-year waiver from filing electronically can be requested on Form 8508 at least 45 days before the due date.

Refer to the IRS instructions for when Forms 1099 are required and the type of information that must be reported.  The penalties for not filing Forms 1099 with correct information when required are shown below.  The amount of the penalty varies upon the timeliness of correcting mistakes and whether your business qualifies as a small business.  A small business is one whose average annual gross receipts for the three most recent prior tax years (or period of existence if shorter) are $5 million or less.  Note that the penalties shown must be doubled because the penalties apply separately, once for not timely providing correct information to payees and again for not timely reporting correct information to the IRS.

1. $30 per 1099 if you correctly file within 30 days of the due date.  Maximum penalty is $250,000 ($75,000 for a small business).
2. $60 per 1099 if you correctly file after 30 days of the due date but by August 1st.  Maximum penalty is $500,000 ($200,000 for a small business).
3. $100 per 1099 if you correctly file after August 1st.  Maximum penalty is $1,500,000 ($500,000 for a small business).
4. Failure to file electronically when required is another $100 per 1099 above 250.
5. Intentionally disregarding the duty to file Forms 1099 when required is $250 per 1099 with no maximum penalty.

Penalties can be waived for reasonable cause, not for willful neglect.  Also, an inconsequential error or omission is not considered a failure to report correct information.  A special de minimis rule applies for corrections made by August 1st; see the instructions.

New Corporate Stock Basis Transaction Reporting Form Due January 17, 2012

The IRS has been developing many new information reporting tax forms to assist them in conducting "behind the scenes" audits of taxpayers.  My blog of January 4, 2012 discusses the new capital gains reporting form, and the fact that brokers must track the tax basis of their customers' stock purchases after 2010.  New Form 8937 applies to corporations that undertake an "organizational action" after 2010 that affects the tax basis of its stock held by its shareholders.  This new form not only assists stockbrokers in tracking stock basis, but also provides information to the IRS for its purposes.  Form 8937 is required to be filed with the IRS by the 45th day following the organizational action (or by January 15th of the following year if that date is earlier than the 45th day).  A transition rule permits the filing of this form for 2011 actions by January 17, 2012.  A late filing penalty of $100 is assessed for each failure to file with the IRS, up to an annual maximum of $1.5 million.  A like penalty also applies for failure to furnish the information to a shareholder.  Information must also be furnished to the shareholders by January 15th of the year following the calendar year of the organizational action.  So the total penalty can be $200 per shareholder up to $3.0 million!

Examples of "organizational actions" that must be reported include the following:

• A non-dividend cash distribution to shareholders (meaning the distribution exceeds "earnings and profits"),
• A stock dividend to shareholders,
• A tax-free stock split,
• A tax-free spin-off,
• A tax-free acquisition,
• A redemption of stock by the corporation, and
• A leveraged recapitalization.

Exceptions from reporting include initial public offerings, the issuance of stock to someone exercising a right to purchase stock, and distributions that will be reported as taxable dividends reported on Form 1099-DIV.  No exception is provided for privately-owned corporations.  In lieu of using Form 8937, corporations can post the information to their primary public website that remains accessible to the public for 10 years.  In addition, an S corporation can avoid using Form 8937 if it reports the effect of the organizational action on a timely filed Schedule K-1 for each shareholder and timely gives a copy to all proper parties.

The very tight reporting deadline means that you may not have all of the information necessary to accurately complete the form.  The IRS instructions state, "To report the quantitative effect on basis by the due date, you may make reasonable assumptions about facts that cannot be determined before the due date.  You must file a corrected return within 45 days of determining facts that result in a different quantitative effect on basis from what was previously reported."  An acquiring or successor entity must satisfy the reporting obligations if the acquired corporation has not done so, as both entities are jointly and severally liable for any penalties.  This new form obviously creates a burdensome obligation upon affected corporations!

New California Law Regarding Worker Misclassification

A new California law (SB 459) became effective January 1, 2012, to make it unlawful to voluntarily and willfully misclassify a worker as an independent contractor instead of an employee in the state.  The new law also states that businesses may not deduct from a misclassified independent contractor any fee or charge for work-related expenses where such amounts are not permitted to be charged against a regular employee's pay.  State civil penalties from $5,000 to $25,000 for each violation may be assessed.  In addition, licensed contractors can lose their state license to operate.  Advisors (other than employees or attorneys) who knowingly advise a business to misclassify a worker as an independent contractor may be jointly and severally liable for these penalties.

Businesses may try and save money by misclassifying their workers as independent contractors.  However, federal and state governments are cracking down on this abuse.  A misclassified worker not only loses out on potential unemployment and workers' compensation benefits, they may also lose out on benefits provided by the business to regular employees.  Furthermore, the government believes it is missing some employment tax revenue when a worker is misclassified because there is no withholding by the employer on the worker's compensation. 

Any mistakes in misclassifying workers should be corrected as soon as possible.  The IRS currently has a Voluntary Classification Settlement Program in effect that permits employers to correct past mistakes in misclassifying workers.  See my blog post dated October 3, 2011.

New Rules for Reporting Capital Gains

The 2011 tax return reporting of capital gain transactions has been substantially modified.  The new procedures are implemented in accordance with the Emergency Economic Stabilization Act of 2008.  The change is expected to increase tax revenues by $6.7 billion over 10 years by increasing the amount of information brokers must report to the IRS on Form 1099-B (or substitute statement) upon the sale of investments.  For publicly traded securities, brokers must now report in addition to the sales date and price, the tax basis and whether the sale is a short-term or long-term capital gain or loss.  The additional information will be used by IRS computers to monitor compliance by taxpayers who might otherwise under-report their capital gains.  The basis information is reported on "covered securities."  Covered securities are defined as follows:

1. Stocks purchased after 2010,
2. Mutual funds and exchange-traded funds (ETFs) purchased after 2011, and
3. Options and bonds purchased after 2012.

In determining the tax basis of covered securities sold, brokers will use either a "first-in, first-out (FIFO)" or "average cost" method.  You have the right to elect to use the "specific identification" method wherein you tell the broker in writing which shares are to be sold.  Most brokers request that you communicate your method to them prior to the sale.  Significant differences in the basis amount can result, depending upon the method used.

Details of capital gains and losses are no longer reported on Schedule D or D-1.  Instead, use new Form 8949, Sales and Other Dispositions of Capital Assets.  Summary amounts are carried from Form 8949 to Schedule D.  The new form requires transactions be sorted into three separate categories using a separate Form 8949 for each category.  If you have both short-term and long-term sales, you could have six separate Forms 8949!  The segregation into categories facilitates IRS computer auditing of your capital gains and losses.  The three categories are:

1. Transactions reported on Form 1099-B with the tax basis reported to the IRS,
2. Transactions reported on Form 1099-B but the tax basis is not reported to the IRS, and
3. Transactions not reported on Form 1099-B.

Brokers may mistakenly report incorrect tax basis to the IRS.  Form 8949 requires any corrections to the tax basis reported to be separately disclosed along with designating a pre-determined code as set forth in the instructions to explain the reason for the correction.

These new reporting rules will increase the cost and burden of compliance.  The rules essentially require taxpayers to do the work normally associated with preparing for an IRS tax audit.

Temporary Payroll Tax Cut

On December 23, 2011, Congress passed, and the President signed, legislation that extends the 2011 temporary payroll tax cut by two months, to the end of February 2012.  The Federal Insurance Contributions Act (FICA) consist of two separate taxes:  6.20% on the first $106,800 (for 2011) of compensation for Old Age, Survivors and Disability Insurance (OASDI); and 1.45% on all compensation without limit for Medicare Hospital Insurance.  These taxes are imposed on both the employee and the employer.  For 2011, the 6.20% rate was reduced to 4.20% for the employee's share only.  The rate reduction expired December 31, 2011, and Congress squabbled over how to extend the tax cut into 2012.  Congress only managed a two-month extension and so will need to address this issue again shortly.  A similar extension was made for the self-employment tax rate.

In 2012, the OASDI tax applies to the first $110,100 of compensation.  However, the new law only permits the 2% rate cut to apply to the first $18,350 of 2012 compensation (two-twelves of $110,100) during January and February by means of a 2% recapture tax.  This provision prevents those who can control the timing of their compensation from front-loading their compensation to gain the full benefit and also relieves a burden on employers to monitor the tax withholding rate based upon the amount of compensation paid during this two month period.  The recapture tax would be paid on the employee's 2012 income tax return.  However, the recapture provision only applies if the rate cut actually ends on February 29, 2012.  Congress is expected to extend the tax cut to all of 2012.

Last Minute 2011 Year-End Tax Planning

Even at this late date in December, there are "last minute" steps that you can take to save income taxes.  The following bulleted list briefly describes a number of these steps.

1. Determine your 2011 and 2012 marginal income tax rates.  The marginal rate is the tax rate you would pay on the next one dollar of income.  If your 2011 marginal tax rate is lower than what you anticipate for 2012, then try to accelerate income into 2011 and defer deductions into 2012.  Do the reverse if your 2011 tax rate is higher than your 2012 rate.
2. Consider selling stocks for which you have capital losses in order to reduce the amount of your capital gains subject to tax.  Be careful to avoid the "wash sale" rule when reinvesting the sale proceeds.  The wash sale rule prohibits tax losses on the sale if the same security is purchased within the 30-day period before the date of sale and within the 30-day period after the date of sale.
3. Consider converting a portion of your traditional IRA or 401(k) account into a Roth IRA or Roth 401(k) account by December 30th.  The conversion is essentially a question of tax rates in the year of conversion vs. your tax rate in retirement.  If you are in the 15% bracket in 2011, convert enough to fill up the 15% rate bracket which extends to taxable income of $69,000 for joint filers and $34,500 for single filers.  Taxable income is your net income after all deductions and exemptions.  Before converting, be sure that you have enough cash outside the retirement account to pay the conversion tax.  This idea saves future taxes since the Roth account is tax-exempt.
4. For those age 70 1/2 or older, don't forget to receive the 2011 required minimum distribution from your IRA or qualified retirement plan.  Failure to take the RMD incurs a 50% penalty on the amount not taken.  Ending this year is the ability to make a direct charitable contribution from your IRA and have it count as part of your 2011 RMD.  Certain rules and limitations apply.
5. For those who would like to reduce their taxable estate, make a $13,000 present-interest gift to your heirs before the end of the year.  To be considered a completed gift in 2011, gifts made by check should be deposited in the bank by the recipient no later than December 30, 2011.  Each year there is a $13,000 "annual exclusion" from the gift tax.  It is a "use it or lose it" tax benefit.  For a married couple, the gift can be doubled to $26,000 if each spouse participates.

Big tax changes are on the horizon given the need to address the federal budget deficits, and because the so-called Bush tax cuts expire at the end of 2012.  The year 2013 could be the year for important tax changes.  We will keep an eye out on these changes and report on them in future blog posts.

Home Energy Credit Expires After 2011

A personal income tax credit of $500 is available for certain energy-saving home improvements completed by December 31, 2011.  Prior to 2011 the credit was much larger in amount.  The energy credit expires after 2011, so now is the time to complete any needed improvements to your home that can qualify for the tax credit.  This credit has a lifetime limit of $500 of which only $200 may be claimed for windows.  If you claimed this credit in the amount of $500 or more since 2005, no further credit may be claimed in 2011.  The energy credit may offset the 2011 alternative minimum tax.

The 2011 credit is 10% of the cost of certain energy efficient improvements as follows:

1. Insulation, exterior windows and doors, and certain roofs.  The cost of installing these items is not included in the credit calculation.
2. High-efficiency heating and air conditioning systems, water heaters, and stoves that burn biomass fuel.  The cost of installing these items is included in the credit calculation.

Only improvements that meet certain energy savings standards qualify for the credit.  Check the manufacturer's tax credit certification statement before purchasing.

Significant additional tax credits are available for homeowners installing certain alternative energy equipment, such as solar power, geothermal, wind, and fuel cell technologies.  See the IRS website at http://www.irs.gov/newsroom/article/0,,id=249922,00.html for more information.