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Don't get caught in 1099 tax trap

New rules for reporting payments to companies and vendors could trip up small businesses. The IRS' goal is to catch tax cheats.

By MSN Money Partner Mar 20, 2012 11:58AM

This post is by Laura Saunders of The Wall Street Journal.

 

A pair of changes for 2011 could mean big headaches for taxpayers who report business or partnership income on their individual tax returns.

 

Both changes involve so-called 1099 forms, which are reports submitted to the Internal Revenue Service so the agency can cross-check information from different taxpayers.

 

The first change is momentous: It requires third parties -- credit- and debit-card issuers, PayPal and the like -- to tell the IRS about their payments to businesses. For 2011 and after, these firms must issue 1099-K forms to the IRS and the taxpayer giving the amount of such payments.

 

Why does that matter? This information can help the IRS flush out unreported income by small businesses. Cheating and mistakes cost Uncle Sam $122 billion a year, the IRS estimates, making it the largest single element of the $385 billion in annual unpaid taxes, known as the tax gap.

 

The new third-party payment information cuts two ways. It can help the IRS identify companies, such as online merchants, who aren't reporting income at all. But it also can shine a light on businesses that are underreporting their income, such as a restaurant that does a big cash business but declares income equal only to its credit- and debit-card payments.

There is some good news on the 1099-K front: After an outcry by the National Federation of Independent Businesses, or NFIB, and other groups, the IRS recently decided to drop plans to have businesses break out 1099-K receipts on their tax forms. Doing so would have imposed a huge burden, says Chris Walters, an official with NFIB, because it involved an onerous reconciliation process.

 

"Grocery stores would have had to show that $15 of a shopper's $40 debit charge was for food and the rest was a cash withdrawal, or else the IRS might think they're underreporting income," he explains.

 

But business owners shouldn't be lulled into a false sense of security. While they won't have to report the information on their returns, third parties must still provide 1099-Ks, and the IRS can still use those data in audits.

 

"Firms that might be 'outed' by this form should remember it's very much alive," says Don Williamson, a tax preparer who heads the Kogod Tax Center at American University.

 

The other potential trap: two new lines on several forms, including Schedule C (for sole proprietorships), Schedule E (landlords), 1120S (Subchapter S corporations) and 1065 (partnerships).

 

Those lines ask: "Did you make any payments in 2011 that would require you to file Form(s) 1099?" and "If 'Yes,' did you or will you file all the required Forms 1099?"

 

These simple-seeming questions could cause large penalties for some taxpayers.

 

Here is why: Firms usually are required to issue 1099 forms to providers of more than $600 worth of services during the year, unless the vendors are incorporated. That could include, for example, an accountant, a plumber, a website designer or a consultant.

 

In 2010, Congress stiffened penalties on taxpayers who neglect to provide 1099 forms. The higher penalties took effect in 2011, and now the penalty for nonfiling is $100 per violation -- $200, in most cases, because two forms are due, one to the IRS and one to the provider. The penalty for "intentional failure to file" is $250.

 

Williamson recalls one case in which penalties for multiple vendors and multiple years amounted to $35,000, even though nothing else on the return was disallowed.

 

By asking the two questions prominently on the return, the IRS is both reminding taxpayers of their obligations and setting a snare for scofflaws. If a taxpayer answers "no" and an audit shows he should have sent the forms, the answers could be evidence in favor of higher penalties. So "he's hoisted on his own petard," Williamson says.

 

In extreme cases, he adds, it would be easier for the IRS to allege civil fraud, because the taxpayer's answer is evidence that he or she was willfully noncompliant.

 

More from The Wall Street Journal and MSN Money:

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7Comments
Mar 20, 2012 2:07PM
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These are only problems if you are cheating on your taxes. If you keep things legit why would it matter? I have been self employed since I was 22 and everyone with anyone doing some of the work for or with them knows the magic line is $600. Everyone also knows that if you mess around with the IRS for a while you will get an audit sooner or later. 
Mar 20, 2012 3:47PM
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The Real Crooks ....

Maybe the IRS should be looking for the 'real' tax money that's due the government ... from Big Oil. Of course the oil corporations will never pay what they really owe because of their incredible number of write offs, loopholes and the obscene hidden assets of their offshore shell companies. All of this on top of the fact that Big Oil and their lobbyists literally own most of our 'esteemed' 100 Senators and 435 Congressmen on Capitol Hill, (which should be spelled Capital Hill), to do their bidding. The fix is in on the little guy in this country while the elite fat cats smoke Macanudos, sip Napoleon Brandy and count their tax free cash in the Cayman Islands.

 

Peace to all

Mar 20, 2012 7:57PM
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Ban the IRS, they and Congress are thieves...we the people need to crush these anti-american slugs!
Mar 20, 2012 7:28PM
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Crack down on the tax cheats and make the people in the cart pay some taxes......no free lunch.
Mar 23, 2012 12:56AM
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This just shut me down. I don't mind paying but what is up with all the Goverment waste?  Out of business!  Colorado
Apr 8, 2012 7:52AM
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Let the IRS go after all the crooked politicians. 
Mar 23, 2012 12:57AM
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This just put my small business out of business. I don't mind paying but hate the Government waste.  Arvada, Co
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