Let’s be honest: no one likes 1099s.
I get it. The government has conscripted us – business
owners and their advisors – into unpaid volunteers for the IRS. Perhaps it started
innocently enough, but with the passage of years and the accretion of reporting
demands, information reporting has become a significant indirect tax on
businesses.
It’s not going to get better. There is a proposal in
the White House’s Green Book, for example, mandating banks to report gross
deposit and disbursement account information to the Treasury.
Back to 1099s.
You see it all the time: one person pays another in
cash with no intention – or ability – to issue a 1099 at year-end.
What can go wrong?
Plenty.
Let’s look at Adler v Commissioner as an
example.
Peter Adler owned a consulting company. He had a
significant client. He would travel for that client and be reimbursed for his
expenses.
The accounting is simple: offset the travel expenses
with the reimbursements. Common sense, as the travel expenses were passed-on to
the client.
However, in one of the years Peter incurred expenses
of approximately $44 thousand for construction work.
The Court wondered how a consultant could incur
construction expenses.
Frankly, so do I.
For one reason or another Peter could not provide
1099s to the IRS.
One possible reason is that Peter made his checks out
to a corporation. One is not required to issue 1099s to an incorporated
business. Peter could present copies of the cancelled checks. He could then verify
the corporate status of the payee on the secretary of state’s website.
Nah, I doubt that was the reason.
Another possibility is that Peter got caught deducting personal expenses. Let’s assume this was not the reason and continue our discussion.
A third possibility is that Peter went to the bank,
got cash and paid whoever in cash. Paying someone in cash does not necessarily
mean that you will not or cannot issue a 1099 at year-end, but the odds of this
happening drop radically.
Peter had nothing he could give the Court. I suppose
he could track down the person he paid cash and get a written statement to
present the Court.
Rigghhhtttt ….
The Court did the short and sweet: they disallowed the
deduction.
Could it get worse?
Fortunately for Peter, it ended there, but – yes – it
can get worse.
What if the IRS said that you had an employee instead
of a contractor? You are now responsible for withholdings, employer matching,
W-2s and so on.
COMMENT: You can substitute “gig worker” for contractor, if you wish. The tax issues are the same.
Folks, depending upon the number of people and dollars
involved, this could be a bankrupting experience.
Hold on CTG, say you. Isn’t there a relief provision
when the IRS flips a contractor on you?
There are two.
I suspect you are referring to Section 530 relief.
It provides protection from an IRS flip (that is, contractor
to employee) if three requirements are met:
1. You
filed the appropriate paperwork for the relationship you are claiming exists
with the service provider.
2. You
must be consistent. If Joe and Harry do the same work, then you have to report
Joe and Harry the same way.
3. You
have to have a reasonable basis for taking not treating the service provider as
an employee. The construction industry is populated with contractors, for
example.
You might be thinking that (3) above could have saved
Peter.
Maybe.
But (1) above doomed him.
Why?
Because Peter should have issued a 1099. He had a business.
A business is supposed to issue a 1099 to a service provider once payments
exceed $600.
There was no Section 530 relief for Peter.
I will give you a second relief provision if the IRS
flips a contractor on you.
Think about the consequences of this for a second.
(1) You were supposed to withhold federal income
tax.
(2) You were supposed to withhold social security.
(3) You were supposed to match the social
security.
(4) You were supposed to remit those withholdings and
your match to the IRS on a timely basis.
(5) You were supposed to file quarterly employment
reports accounting for the above.
(6) You were supposed to issue W-2s to the
employee at year-end.
(7) You were supposed to send a copy of the W-2 to
the Social Security Administration at year-end.
(8) Payroll has some of the nastiest penalties in the
tax Code.
This could be a business-shuttering event. I had a
client several years ago who was faced with this scenario. The situation was
complicated by fact that the IRS considered one of the owners to be a tax
protestor. I personally did not think the owner merited protestor status, as he
was not filing nonsense appeals with the IRS or filing delaying motions with
the Tax Court. He was more … not filing
tax returns. Nonetheless, I can vouch
that the IRS was not humored.
Back to relief 2. Take a look at this bad boy:
§ 3509 Determination of employer's liability for certain
employment taxes.
If any employer fails to deduct and withhold any tax under
chapter 24 or subchapter A of chapter 21 with respect to any employee by reason
of treating such employee as not being an employee for purposes of such chapter
or subchapter, the amount of the employer's liability for-
Tax under chapter 24 for such year with respect to such employee
shall be determined as if the amount required to be deducted and withheld were
equal to 1.5 percent of the wages (as defined in section 3401
) paid to such employee.
(2) Employee social
security tax.
Taxes under subchapter A of chapter 21 with respect to such
employee shall be determined as if the taxes imposed under such subchapter were
20 percent of the amount imposed under such subchapter without regard to this subparagraph
.
Yes, you still owe federal income and social security,
but it is a fraction of what it might have been. For example, you should have
withheld 7.65% from the employee for social security. Section 3509(a)(2) gives
you a break: the IRS will accept 20% of 7.65%, or 1.53%.
Is it great?
Well, no.
Might it be the difference between staying in business
and closing your doors?
Well, yes.
