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Tom Talks Taxes - September 15, 2023
How to handle a Form 1099 issued to an individual instead of a corporation
When a business pays a nonemployee worker more than $600 during a calendar year for services, it must issue that worker Form 1099-NEC, Nonemployee Compensation. Form 1099-NEC is an imperfect information reporting document.
First and foremost, the $600 threshold is burdensome. Businesses must track and report minimal payments, and the IRS has an avalanche of data that its antiquated systems attempt to match (often unsuccessfully). The $600 has been static since 1954; if inflation adjusted, the threshold would be somewhere in the $5,000 to $6,000 range. House Republicans have proposed increasing the threshold to $5,000.
Second, it reports payments made by the employer during the tax year; however, that amount is not always the gross income the worker should realize under their method of accounting. There is no method of reconciling the Form 1099-NEC to the gross receipts reported under the taxpayer’s method of accounting and books and records.
Third, the IRS always assumes payments made on Form 1099-NEC are subject to self-employment tax; however, if the amount is not received in a taxpayer’s trade or business activity, it is not subject to self-employment tax. Many businesses also improperly report payments that should go on Form 1099-MISC, Miscellaneous Income, on Form 1099-NEC.
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Last and most relevant to the main topic of this article, the business can issue Form 1099-NEC to the wrong taxpayer identification number, causing reporting headaches and possible IRS notices about document-return mismatches.
Before concluding that the Form 1099-NEC is incorrectly reported to the individual, be sure that the corporation actually earned the income. Under the longstanding assignment of income doctrine, first promulgated in Lucas v. Earl, 281 U.S. 111 (1930), income cannot arbitrarily be assigned from one taxpayer to another taxpayer.
In Fleischer v. Comm., T.C. Memo 2016-238, the Tax Court noted that
Because it is impractical to apply a simplistic "who earned the income" test when the Court's choices are a corporation and its service-provider employee, the question has evolved to one of "who controls the earning of the income."
The Tax Court continued to explain the two essential elements required for a corporation, and not its service-provider employee, to be the controller of the income:
(1) the individual providing the services must be an employee of the corporation whom the corporation can direct and control in a meaningful sense… and
(2) "there must exist between the corporation and the person or entity using the services a contract or similar indicium recognizing the corporation's controlling position"…
If the worker, and not the corporation, is the contracted service provider, they rightly earned the income, and the following options should not be considered.
Option 1: Get a Corrected Form 1099-NEC. This should always be the first step in the process. In some circumstances, an identity theft issue must be addressed with the business that issued the form.
Option 2: Use the Nominee Recipient Procedure. General Instructions for Certain Information Returns (2023), p. 3, outlines the following procedure:
Generally, if you receive a Form 1099 for amounts that actually belong to another person, you are considered a nominee recipient. You must file a Form 1099 with the IRS (the same type of Form 1099 you received) for each of the other owners showing the amounts allocable to each. You must also furnish a Form 1099 to each of the other owners. File the new Form 1099 with Form 1096 with the IRS Submission Processing Center for your area. On each new Form 1099, list yourself as the “payer” and the other owner as the “recipient.” On Form 1096, list yourself as the “Filer.” A spouse is not required to file a nominee return to show amounts owned by the other spouse. The nominee, not the original payer, is responsible for filing the subsequent Forms 1099 to show the amount allocable to each owner.
Option 3: Use the Announced Form 1099-K Procedure. The recent expansion of Schedule 1, Additional Income and Adjustments to Income, provides opportunities to present transactions in ways previously unavailable. In Fact Sheet 2023-06, Individuals Q&A 2, the IRS promulgated a procedure for incorrect Form 1099-Ks:
Q2. What do I do if I think my Form 1099-K is incorrect? (updated December 28, 2022)
A2. If you believe the information on Form 1099-K, Payment Card and Third Party Network Transactions, is incorrect, the form has been issued in error, or you have a question relating to the form, contact the filer, whose name and contact information appears in the upper left corner on the front of the form.
You may also contact the payment settlement entity whose name and phone number are shown in the lower left side of the form.
If you cannot get the form corrected, the error should be reported on Form 1040, Schedule 1, Additional Income and Adjustments to Income, Part I, Additional Income, Line 8z, Other Income, with an offsetting entry in Part II, Adjustments to Income, Line 24z, Other Adjustments.
For example, you took a trip with your friend and you paid for the airline tickets. If your friend reimburses you $2,500 for their airline tickets, and you received a Form 1099-K reporting the $2,500 as gross proceeds, your Schedule 1 should reflect the following:
Form 1040, Schedule 1, Additional Income and Adjustments to Income Part I – Line 8z, Other income. List type and amount: “Form 1099-K Received in Error …. $2,500” to show the proceeds reported on the Form 1099-K and Part II – Line 24z, Other adjustments. List type and amount: “Form 1099-K Received in Error…. $2,500” to offset the proceeds reported to you in error.
The same procedure can be used in this case, simply substituting Form 1099-NEC for Form 1099-K. The procedure indicates that getting a corrected Form 1099 is always the first step.
Disclosure. In all cases, disclosing the position that the Form 1099-NEC amount is not gross income to the taxpayer and also not subject to self-employment tax is prudent. Using Form 8275, Disclosure Statement, is not a “red flag” to the taxpayer; it protects both the taxpayer and tax professional and apprises the IRS of the correct position being taken on the tax return.
The “Detailed Explanation” should not be overly specific. For example, “The taxpayer received an erroneous Form 1099-NEC. The amount listed is neither gross income nor net earnings from self-employment to the taxpayer” is sufficient.
Do Not File a False Schedule C. The individual is not engaged in a trade or business activity; do not creatively make one up to deceive the IRS’s computer system. There are other legitimate options to address the issue, as outlined above.
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