1099s and Weatherly v Commissioner

There are two new questions on your income tax returns this year:

·         Did you make any payments in 2011 that would require you to file Form(s) 1099?

·         If “Yes,” did you file or will you file all required Forms 1099?

Several points come immediately to mind:

·         Remember that you are signing this return as being “true, correct and complete” to the best of your knowledge.

·         I, as the preparer, have to exercise due diligence by also asking you this question.

·         What are the consequences of answering “No?”

Congress will be unsatisfied until it has combed your sofa cushions for loose change. This pressure unfortunately passes down to the IRS, and we are seeing the results in OVDI, FATCA, automated collections and taxpayer liens. Obviously they believe there is money to be found here.

This brings us to Jeremiah Weatherly v. Commissioner (TC Memo 2011-206). It’s a tax case having to do with Forms 1099.

JW operated a bailiff consulting business. These are people who perform evictions and serve process, for example. He hired daily workers to help out. He must have been doing relatively well, as he reported $177,925 of Contract Labor on his 2005 return.

He got audited. The IRS wanted his Forms 1099. JW provided the IRS with 64 Forms 1099.There was a problem, however. JW had not filed the Forms with the IRS.

                OBSERVATION: Really, JW?

The IRS now had no confidence in the 64 Forms 1099, so they requested JW obtain and submit Forms 4669 from the 64 people. Form 4669 requires the payee to report the amount of the payment and where it is reported on his/her return.

OBSERVATION: This is not going to go over well.

JW’s response rate was pretty much what you would expect: he got eight replies. The IRS bounced 2 of them, as the social security numbers were invalid. With the remaining six, JW was able to document $25,115 of his Contract Labor expense. The IRS simply disallowed the remaining $152,810.

JW appealed pro se to the Tax Court. He got schooled. Tax law and long-standing tax doctrine require a taxpayer to maintain records sufficient to establish the amounts of allowable deductions and enable the Commissioner to determine the correct tax liability. This is a two-step requirement: your records have to be good enough for you to prepare a correct return AND to allow someone to double-check your work.

The Tax Court asked for JW’s books and records. Nothing. The Tax Court asked for other evidence to substantiate that these amounts were actually paid. Nothing. The Court then wanted JW to testify about his bookkeeping practices. Nothing. Frustrated, the Court held for the IRS. JW got charged with additional tax of $67,436 and penalties of $29,425.

What can we learn from JW?

Let’s admit, JW should never have represented himself. All he accomplished was to aggravate the Court. It is possible that another taxpayer – more responsive and attuned – could have obtained a different result. The Court did try to help JW, even alluding to the Cohan rule where it will allow estimates as long as the Court is convinced that there truly was an expenditure.

Nonetheless, we can see the position the IRS can and may take if one fails to file Forms 1099. Perhaps your bookkeeping practices are different from JW’s, and you could have provided the Court with substantial and satisfactory alternative documentation. However remember that you would have engaged – and paid – a tax CPA to represent you at audit and Appeals before even arriving at the Court. And you would still be at the Court’s mercy.

This process seems expensive to me. Here is another idea: issue 1099s, especially since you are now required to affirmatively respond to the new questions on your 2011 tax returns. There is now one more reason for the Court to turn you down: you lied when you answered “No” to the first question.