1099s and W-9s

Who needs to file a Form 1099?

Any business or self-employed individual that pays $600 or more to any individual or LLC in a given year is required to issue a Form 1099 by January 31st of the next year. For 2012, that deadline will be January 31, 2013.

The provision for owners of rental properties is new. It is now a requirement to issue a 1099 for any vendor to which a rental property owner pays more than $600, whether it’s a management company, a plumber or exterminator – you’re required to issue this form.

The reason for this is that the government knows there are many vendors out there who are not reporting their correct income. By requiring a 1099, they can go after those people.

The first step in complying with the requirement is obtaining a completed form W-9 from every individual or LLC you do business with. It should be a matter of practice to have a stack of these forms printed out in your office on your desk, or even in the form of a PDF saved on your desktop.

By having this on file at the end of the year, it is just a matter of preparing the corresponding 1099 and sending it out. The problem is that many times if you don’t get the W9 when you hire the person or before you pay them, it might be difficult to track them down at the end of the year. It could be that they’ve gone out of business, moved, or they just don’t want to report the income so they’re avoiding you. This is why it is so important to get their W9 before you exchange any goods, services, or payments.

In addition to keeping all the W9s on file physically, software like QuickBooks have the tools to keep track of this information, in addition to keeping a tally of what you’ve paid out. If you don’t use QuickBooks, an Excel or other spreadsheet can also do a fine job recording how much you’ve paid each contractor. Keeping good books and records will help assure that issuing 1099s at the end of the year is a very easy process.

What if I fail to issue 1099s?

The biggest problem with not keeping the requirement is that the government can technically disallow the expense under audit. For example, legal and professional fees are one of the categories that are being targeted. If you have $5,000 under legal and professional fees at the end of the year, and you haven’t issued a 1099 to that attorney or that accountant or whoever that professional was, then the IRS could disallow it and assess you additional taxes, penalties and interest.

An invoice or canceled check can definitely help your case, but issuing a 1099 is usually more than enough evidence to prove a legitimate expense. With the 1099, the IRS can leave you alone and if needed, go after that lawyer or accountant or whoever that contractor was. So the 1099 takes the liability off of you and puts it on the person you paid.

The IRS added a 2-part question on all types of tax returns starting in 2011. These are not the actual questions from the tax return; they’ve been paraphrased.

Did you pay any individual or LLC $600 or more during the year xxxx?
Did you file that 1099?

These questions are probably more designed to intimidate taxpayers more than anything right now, but if you read between the lines they’re basically saying: “You need to do this, and if you don’t, there are going to be penalties, fines and interest. And if you do not start complying now, things will happen that are worse than that.”

What are the ramifications for a contractor who does not report income from a client who has filed a 1099 for him or her?

You’re definitely going to get a notice from the IRS saying, “Why didn’t you report this income?” The notice is called a CP2000 which is not only a notice, but a tax bill saying, “You didn’t report this income. You owe us this amount of money”.

For example, if you didn’t report $5,000 of a 1099 from one of your customers, they’re going to tax you on the whole $5,000 on that CP2000. Now you probably have at least some type of expense against that income – unless you’re running some great, 100% profitable business, you’re going to get assessed more tax than you really should have to pay.

If you get that notice it’s not too late; you can dispute it which means you’re probably going to have to amend your tax return to include that income and also include the expenses against that income. There is still a chance to pay the right amount of tax but there will be penalties and interest, which will probably not be waived. They don’t mind lowering the tax to the correct amount, but they’re most likely not going to waive your penalties and interest because you’re paying the tax late. You should have paid it when you were filing your return.

What if my vendor is from abroad or does not have a Social Security number or Tax ID number?

If a business is paying a foreign vendor who is performing services in the United States, and they cannot give you a W9 because they don’t have a social security or Tax ID number, then the business is usually required to withhold 30% of the fee. That 30% then needs to be remitted to the IRS and filed with another form, called the 1042. A 1042 is similar to a 1099 except the 1042 applies to foreign people when you withhold the 30% required by the IRS. It then becomes the responsibility of this foreign person to file a 1040-NR to stay in compliance with US tax laws and perhaps get a refund.