The IRS has declared war on the underreporting of income and is taking the most aggressive approach ever in their ability to enforce compliance with new 1099 regulations. Many IRS auditors are now denying deductions for payments by businesses that fail to issue required 1099s, even if unintentional.
The IRS penalty trap
Since 2012 business tax returns have two questions that all businesses must answer, or risk an audit. They are:
- Did your business make any payments that would require filing form(s) 1099, and
- If yes, did your business file or will it file form(s) 1099?
What are the consequences to your answers?
- You are required to check the box “yes” or “no”.
- Your tax returns cannot be e-filed or accepted by the IRS without the boxes being checked (even if you filed a paper return).
- If you answer “yes” to the first question and “no” to the second question, you will likely be subject to an IRS correspondence audit.
- If you check the box that states that you were required to file forms 1099 but you failed to do so, then you have intentionally disregarded the 1099 reporting rules and are subject to penalties.
- If you state that you were not required to file Form 1099 and it is later shown that you were, you have intentionally disregarded the 1099 reporting rules and lied on your tax return, thereby subjecting yourself to the maximum penalty, as well as whatever penalty of perjury
- You may also be subject to an IRS penalty for failure to collect and remit the 28 percent backup withholding, if you failed to have the payee complete Form W9. The penalty is equal to the 28 percent that you should have withheld.
The purpose of the IRS in asking these questions is to get you to self-incriminate yourself. The answers that you give are ultimately made under penalty of perjury when you sign your tax return or e-file form.
What are the consequences for not complying?
If you don’t issue 1099s when required, your business may not get a deduction for the expense if audited and you may incur penalties for failure to file 1099s. (See our article: “The Consequences for Failing to Comply with the 1099 Rules” for more details).
The California Franchise Tax Board has statutory authority to disallow deductions and assess penalties to businesses that fail to issue and file proper 1099s. Even though the IRS does not have the statutory authority to disallow expenses for failing to file 1099s, many IRS auditors are doing it anyway.