Dealing with 1099 Errors - Input Desired

Tax season has started and by now (February 6) we should have our 1099s and W-2s and perhaps a few other reporting forms. We need to review them for accuracy, even forms from the IRS, such as Letter 6419 on the advance Child Tax Credit (see IRS Fact Sheet (FS-2022-5) on possible errors).

Some forms, such as Form 1099-C on cancellation of debt might be correct from the issuer's tax requirements, but not correct for the recipient. For this 1099-C issue, I've blogged on it before (4/13/13 and 6/21/21). The 1099-C instructions also remind the recipient that their debt might not have really been discharged and they should not report the income until the year it has truly been discharged. The IRS doesn't tell the recipient what to do with the 1099-C that isn't reportable. That's too bad because when the recipient figures out it isn't reportable for the year printed on the 1099-C, the IRS doesn't know.

I'm working on a paper for a longstanding activity of the Tax Section of the California Lawyers Association to propose that the IRS create a new form to allow taxpayers to reconcile erroneous reporting forms. Beyond the 1099-C issue, I have the following examples of why a form would help.

Form 1099-K that is way out of line with the recipient's business receipts. Also, starting for this year, there will be more of these forms issued due to the change in the de minimis filing threshold for third party settlement organizations.

Form 1099-INT when the account is owned by more than one taxpayer but only one form was issued.

Form 1099-R for a qualified charitable distribution. While QCD gets noted on the 1040, an explanation on a form might help too.

Form 1098 where the mortgage debt belongs to more than one taxpayer.

What do you think? Any examples you'd like to share with me to support the need for a tax form for reconciling information reports to avoid or hopefully at least lessen the number of notices issued by the IRS asking why the form wasn't fully reported.

Thanks!

New models challenge tax laws

You may have heard the news report that a women in Omaha, battling cancer, received about $50,000 from strangers after she set up an account with GoFundMe. It was also reported that the IRS is seeking $19,000 of income taxes from her on this amount. [See ABC8, 4/27/15 story and KETV.]

The power of the Internet includes to easily reach many people throughout the world enabling vendors to have a larger market, writers to have more readers, and people seeking funds to potentially raise a lot. Crowdfunding websites can generate funds for many purposes and many of these purposes result in taxable income to the recipient. However, not always. What the woman in Omaha received is a non-taxable gift under the income tax law.

A well-known US Supreme Court defines "gift" for tax purposes (Commissioner v. Duberstein, 363 US 278 (1960)). Per the Court:

"A gift in the statutory sense ... proceeds from a "detached and disinterested generosity," Commissioner v. LoBue, 351 U. S. 243, 246; "out of affection, respect, admiration, charity or like impulses." Robertson v. United States, supra, at 714. And in this regard, the most critical consideration, as the Court was agreed in the leading case here, is the transferor's "intention." 286*286 Bogardus v. Commissioner, 302 U. S. 34, 43. "What controls is the intention with which payment, however voluntary, has been made." Id., at 45 (dissenting opinion)."

Basically, if the giver expects nothing in return and the transfer is not for goods or services provided in the past, it is a gift. Clearly, the $50,000 was given with detached and disinterested generosity. The only tax consequences should possibly be gift taxes to the givers if the gift exceeded $14,000.

But, how does GoFundMe know that the transfers to the person in Omaha were a non-taxable gift to her?  GoFundMe is liable for penalties if it fails to report information under any rules it may be subject to. While the law is not entirely clear on what reporting is required by the crowdfunding sites, it likely issues a Form 1099-K to recipients of the funds because it handled the transfer of funds. 

It would be helpful for the IRS to create a new form or schedule allowing recipients of information returns that may be incorrect or improperly sent, to report them, explain them, AND back them out of their income. This would prevent the IRS computers from finding unreported income when it matches a 1099 with the recipient's return and sends out a notice. The new reporting form or schedule would prevent the computer from doing this.

New approaches are sometimes needed for new transactions and this simple solution should work here.  Congress also needs to update information reporting laws to make it clear to web-based businesses when they are required to issue a 1099 (and which type) for funds they collect and transfer to someone.  This would help many companies today beyond the crowdfunding platforms - for example, Uber, Lyft, Amazon Mechanical Turks, Task Rabbit, and more.

What do you think?

Small businesses, IRS notices and the tax gap - repeal 6050W

A recent article in the Wall Street Journal noted that about 20,000 small businesses (out of millions of them) received notices (Letter 5036) from the IRS that they may have underreported their income ("Small Business in IRS Sights," 8/9/13). The article includes quotes from some small business owners rightfully upset that the IRS presumes they have underreported their income and makes them take the time to explain (again - they already did this on their original filed return) what their gross receipts are. The IRS has acknowledged the sending of notices and offers guidance on how to respond.

The problem ties to Form 1099-K, a requirement added to the law in 2008 (IRC Section 6050W). It requires the companies that process credit and debit card transactions for merchants to issue a 1099-K to the merchant and the IRS showing the amount processed.  Paypal and similar processors also have to file, but there is a de minimus threshold for those types of transactions.

There are reasons why the 1099K might not tie to the merchant's proper amount to report as gross receipts. For example, the small business might be a C corporation using a tax year other than the calendar year used for 1099 reporting. Or, as one merchant notes in the WSJ article, the 1099-K includes the sales tax charged to customers - an amount not reported in the small business's gross receipts because the sales tax belongs to the state, not the business.

When 1099Ks were first issued for 2011, the IRS considered adding lines to business returns to make taxpayers separately show gross receipts from 1099Ks versus other forms (such as cash). They dropped that effort though and the tax from said to enter zero on the 1099K line. Forms for 2012 did not ask for any breakdown. (Compare the gross receipts line on the 2012 Schedule C compared to that of 2011.)  So, it looked like the IRS would not be using the 1099K forms it received. That must have been upsetting to the the issuers who incurred significant costs to be able to issue the forms and to actually issue them.

But the IRS said they did have uses for the forms. For example, if the 1099K amount is greater than what was reported for the gross receipts line on the return, they should ask the owner why.  As noted in the WSJ article, the IRS is also asking why the 1099K amount represents a high proportion of gross receipts (or really, that a small amount of cash receipts were reported).  Perhaps the IRS has some industry data on average percentages of receipts from cash versus credit card.  One person interviewed for the WSJ story indicated he sells items that cost $1000 or more so people tend to use credit cards.

This is all troubling for many reasons that indicate a need for improvements to the filing process and congressional efforts to reduce the tax gap.  Here are a few of my concerns and suggestions:

1. A big part of the tax gap (taxes owed but not collected) is due to cash transactions. So, why in 2008 did Congress enact a provision to make credit card processors issue 1099s?  These transactions already have a paper trail. They should have enacted a measure to help identify unreported cash transactions.
2. It is time consuming and frustrating to have to respond to IRS notices.  And worse here is that the IRS could have asked for the information when the return was filed.  Why not ask businesses to describe their billing and customer payments practices. Also ask what the price range is of services or goods sold and the options customers are given for how to pay (cash, check, debit card, credit card, Paypal, barter). This would/should have prevented sending a 1099 to the business that charges $1,000 or more to each customer.  Also, ask on the return how sales tax is reported and the average sales tax rate used. Then the IRS can better understand whether there might be any underreporting.
3. The IRS should be spending more time finding non-filers and auditing cash businesses - sounds like a better way to reduce the tax gap.
4. Section 6050W should be repealed.  It isn't doing much to help reduce the tax gap. I think this is mainly because it is asking for information that already has a significant paper trail (so is likely to be reported). Also, it interferes with better efforts to reduce the tax gap. For example, a long standing rule (IRC Section 6041) requires businesses to issue a 1099 to someone who provides services to the business and is paid $600 or more.  But what if that service provider is paid via credit card? Then there is double reporting on 1099s (1099 and 1099K).  The effort to prevent this duplicate reporting is error prone, confusing and requires extra recordkeeping by the payors. Repeal 6050W and enact more effective measures to reduce the tax gap.  The GAO has suggested many ideas over the years (as have others).

The House Small Business Committee has sent a letter to the IRS Acting Commissioner with its concerns noted.

What do you think?

Cancellation of debt a growing issue - need for informed tax preparers and changed tax rules

In preparing for an upcoming presentation that basically looks at beyond the current filing season for CPAs, I delved into some data on growing debt problems consumers face. It would appear that more return preparers will be seeing clients with cancellation of debt (COD) forms 1099-A and 1099-C. So more will need to know what COD income is and when it might be excluded under IRC section 108 or when it might just be a property transactions (which is often the case when non-recourse debt is involved). The increase in number of taxpayers with COD income issues may also cause Congress to have to simplify the law, such as by following recommendations made by the National Taxpayer Advocate in 2008. In that year, the report identified COD issues as "the 'poster child' for complexity (report, pages vi and 39-53). (Also see my 2/14/12 post.)

Here is some of the data I found:

Mortgage Bankers Association

• -“1 out of every 200 homes will be foreclosed upon. For a city like Washington, D.C., that translates to 3,000 Washingtonians losing their homes to foreclosure each year. Every three months, 250,000 new families enter into foreclosure.”     (reference)
• •“By several measures, mortgage delinquencies are about half way back to long-term, pre-recession levels.  The total delinquency rate peaked at 10.1 percent in the first quarter of 2010.  It now stands at 7.6 percent, about half way to the longer-term pre-recession average of roughly 5 percent.” (2/16/12 press release)

Corelogic

• •“According to Corelogic’s Negative Equity report, the mortgages on more than 11.1 million homes, or 22.8 percent of the nation’s 48.7 million mortgaged homes, are underwater.” (reference)

Student Loan Data  

• Per the Project on Student Debt, 2/3 college students who graduated in 2010 had debt averaging $25,250, 5% higher than for 2009 
• Per the Department of Education, FY 2009 national student loan cohort default rate was 8.8% (7% for FY2008) 
• Student loan debt exceeds $1 trillion, which is greater than total credit card debt. See "Student-Loan Debt Tops $1 Trillion," by Mitchell and Jackson-Randall, Wall Street Journal, 3/22/12, A5 and information from the Consumer Finance Protection Bureau

IRS

• The IRS projects an increase in the number of 1099-A and 1099-C forms filed (Pub 6961). 

 

Joint Economic Committee

• In December 2011, the JEC released a report that describes various financial information for each state including issues in the mortgage market. For example, for Nevada (page 59), it reports: "As of the 3rd quarter of 2011, 7.9 percent of all mortgages, including 18.8 percent of subprime mortgages, were in foreclosure in Nevada."

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My Recommendations

1. Should any tax rules be modified to address these issues? I think so. One of the possible ways to exclude COD income is if the borrower is insolvent. To measure insolvency, you see if your debts (usually easy to measure) exceed the fair market value of all of your assets (hard to both identify and value). If the person is insolvent, they can exclude the COD income to the extent of insolvency. They must also reduce the basis of their assets by that excluded income. Since the assets are likely things like cars and clothing that are likely to be disposed of at a loss someday, even with the reduced basis, with the loss being non-deductible, the effort to measure insolvency is a wasted one.  I agree with the National Taxpayer Advocate who suggested that there be a dollar amount specified for just being able to exclude COD income (2008 report, pages 391-396). I think the dollar limit should be no higher than $30,000.  Of course, that may seem to fly in the face of the current up to $2 million relief possible for a home mortgage interest (which expires at the end of 2012 unless renewed). For more on the overgenerosity of this particular income exclusion, see a recent law review article by Bradford Anderson - "Robbing Peter to Pay for Paul's Residential Real Estate Speculation: The Injustice of Not Taxing Forgiven Mortgage Debt," Seton Hall Legislative Journal, Vol 36, Issue 1 (2011).
2. The deduction for interest on a home equity loan should be phased out because it encourage people to put debt on their home. While home prices are down and many people do not even have equity in their home, is the time to enact this change.
3. Financial literacy needs to be part of K-12 instruction too to help individuals understand how to keep themselves out of debt and how to save.

What do you think?

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Mileage awards by banks, 1099s, and the realization principle

The excitement about Citibank issuing 1099s to customers who received a prize from the bank that was worth $600 or more has seemed to become yesterday news. But I wanted to expand upon an earlier post on the topic (1/26/12). A Forbes article by Kelly Phillips Erb of 3/1/12 noted that Citibank seemed to have valued the mileage at 2.5 cents per mile which is below what individual might have to pay (2.95 cents per mile). It also noted that some people have filed a lawsuit against Citibank saying they should have told them the award was taxable and they inflated the value.

So, what is wrong with our income tax system that people don't think that when they receive something from a business for doing something, it is not income? Well, people probably don't think the miles or points are really worth much because if they don't get enough points or use them in time, they are not worth anything. A poll by CreditCards.com found that 2/3 of credit cardholders would "stop using their cards if the miles, points and cash back rebates they earn when making purchases were taxed as income" (2/28/12).

But what might those recipients think when they actually use the points such as to get a $300 airline ticket for free? Perhaps they would then consider it income (maybe). Miles or points are different from cash or a toaster or an iPad received as a prize because you might not ever use the miles or points and they might not be salable.

Would it make sense to have a rule that certain items received for doing something (that is, the item is not a gift) are not taxable until used?  The issuer could be required to have a valuation chart posted on its website and perhaps even filed with the IRS.

The income tax has a realization principle. This generally means that there is no income tax effect, such as for property owned, until it is disposed of. That is, you don't need to value your property at year end to see if it appreciated in value and include it as income. In Lakewood Associates v. Commissioner,  109 TC 450 (1997), aff’d 173 F3d 851 (4^th Cir. 1998), where a taxpayer tried to claim a tax loss when property held for business use declined in value, the court said:

"The mere diminution in value of property does not create a deductible loss. An economic loss in value of property must be determined by the permanent closing of a transaction with respect to the property. A decrease in value must be accompanied by some affirmative step that fixes the amount of the loss, such as an abandonment, sale, or exchange"

The bank awards are not similar because the customer does receive something. But customers don't view it as having value until they use it or sell it.


Not taxing the point and mileage awards until used does add some complexity in valuing the items, but not impossible. Taxpayers would like view it as more fair because since the mileage award is a personal asset, if they don't use it, they can't take a deduction for the lost value.  This isn't perfect from a "balance" perspective on the income tax because the bank claims a deduction for buying the miles, but someone may never pick up the income. One solution would be to require banks to only deduct the cost of buying the miles from the airlines if eventually used by a customer. Extra recordkeeping though and it may lead the banks to stop the program. Which might be the best solution. They could use the savings to reduce bank charges.


What do you think?

New Tax Return Details for 2011 Returns - Closing the Tax Gap

Who wouldn't want to see the $345 billion annual federal tax gap reduced? That's a lot of money! One way to make that happen is to be sure more taxable transactions are reported to the taxpayers and the IRS. In the past several years, we have seen a few of these items added, such as the requirement for brokers to report basis on Form 1099-B for stock sales. We also saw Section 6050W enacted to require processors of credit and debit cards have to report the amount processed for merchants to both the merchants and the IRS (Form 1099-K which is new).

Well, these forms are really only useful to the IRS if they can match them against information on taxpayer's returns. So, for 2011, we'll see a few changes in tax forms. For example, gross receipts lines for businesses will have 2 lines - one for amounts shown on 1099-K (credit and debit cards and Paypal) and amounts not on 1099-K (cash and transactions that did not require a 1099-K or someone failed to provide a 1099-K to the merchant).

New forms and lines are also needed for the basis reporting.

I have a short article on the AICPA website (for the Individual Taxation Technical Resource Panel) that explains the new forms and suggests extra activities taxpayers will likely want to undertake to be sure they are properly reporting these new 1099s and reducing the chance of notices from the IRS. Click here.

1099s - manageable for small businesses?

The New York Times article - "Why the New 1099 Rules Aren’t That Bad for Small Businesses" by Robb Mandelbaum (3/14/11) suggests that with software and technology, it is not that difficult to file 1099s including for purchases of goods. It notes, for example, that QuickBooks can track the information and print the 1099s.

I don't think that is entirely correct because the 1099s have to be on scannable forms that are obtained from the IRS, unless electronic filing is used.

The article also notes that if payments are made on credit or debit card, they don't need to be included on a 1099 issued by the purchaser of the goods or services. Well, what if a business uses both check and credit card when buying from particular vendors? I think it has to track it separately and just file a 1099 for the check payments. While software can separate these amounts, will the 1099s be that useful to the recipient?

Also, some of these recipients are publicly-traded corporations that are likely compliant. And, large companies, likely to also be on accrual method and a fiscal year, won't bother reconciling the 1099s - it will be a waste of time.

The cost-benefit of the expanded reporting just doesn't seem to be there. See "1099s - the good, the bad and the ugly," AICPA Corporate Taxation Insider, 11/11/10.

Comments?

Paying for Repeal of Revenue Raisers + A Peek Into Complexity of Section 36B

In 2010, Congress twice expanded 1099 reporting requirements. I think the primary reason for doing so is that the revenue estimates for both indicated they were revenue raisers and that allowed for a tax cut or spending increase. The health care legislation enacted in March 2010 expands, starting in 2012, 1099 reporting to require that they be issued to corporate payees and for goods purchased if the total exceeds $600 for the year. Then in September 2010, Congress added a requirement that landlords, even if not in a trade or business, start issuing 1099s starting for 2011. When both the issuers and recipients of these 1099s start thinking about what it means in terms of hassles and costs and then start thinking about whether it is going to result in more income being reported, it was quite clear that the cost-benefit wasn't there. After all, is the tax gap going to go down if a small business issues a 1099 to Office Depot or American Airlines? No.

But, these provisions went into the law as revenue raisers. I don't really think they were enacted as any serious effort to address the tax gap because they do not really get at the tax gap. And, because of earlier enactment of Section 6050W to require credit/debit card processors and Paypal to issue 1099-Ks to the merchants, to avoid duplicate reporting of items, if you pay using a credit card you don't report that on the regular 1099. What a mess. And, again, this isn't really the way to best address our $345 billion federal tax gap. (For more on that, see a short article of mine - (The Slow Pace of) Closing the Tax Gap.)

Well, the most recent effort to repeal these 1099 requirements is H.R. 4 that passed in the House on Monday with all Republicans voting for it along with 76 Democrats. The apparent objection of some who voted no is that the bill also reduced a particular health care subsidy for taxpayers. More specifically, it modifies IRC Section 36B to increase the amount of overpayment of the health care credit subject to recapture. Those opposing the bill said that was a tax hike requiring a 2/3 vote, but others said a reduction of subsidy is not a tax hike. Wow! A few observations:

1. The 1099 requirements went into the law as revenue raisers, it makes sense that if they go out, some other revenue raiser should take their place.
2. Pay back of a subsidy, a tax hike, a spending cut - does it really matter in terms of the overall effect on the federal budget? No, but ...
3. Isn't a reduction to a benefit provided by a tax rule (IRC Section 36B) a tax increase? If a credit amount were reduced, wouldn't that be a tax increase? Isn't that effect of the proposed Section 36B modification? But, see below on transparency...
4. I encourage you to take a look at Section 36B as added by health care legislation. It is long and complicated. You can find a copy here - go to page 237 (Act section 1401) and it goes on for about 20 pages!

A focus on transparency would be the best approach - just clearly state that when the 1099 requirements were enacted, a revenue increase amount was attached to them. If they are to be repealed, Congress sticks to the same revenue amount and states how it will make up that revenue and how that new provision works. If the 1099 provision was enacted with a simple majority, shouldn't that also work for its repeal (in theory)?

There is an interesting summary of the issue in The Hill's Floor Action Blog of 3/3/11 - here.

Will the new 1099 requirements be repealed? I think so, but it sure is taking a while to get past the revenue aspect of it - being honest about items 1 to 3 above should help move this along. Will there be a more concerted effort to address the tax gap in place of the mostly pointless 1099 provisions enacted in 2010? It doesn't seem so. What do you think?

The 1099 Drama Continues

The expanded 1099 filing requirement brought about in the March 2010 health care legislation and calls for its repeal are starting (continuing?) to look like soap opera drama. There have been a few efforts to repeal the requirement, but with the need to find an offset for the roughly $2 billion per year it was expected to generate, it is difficult to repeal. Also, conventional wisdom is that information reporting helps reduce the tax gap. So, what message is being delivered when a 1099 requirement is repealed? Of course, it needs to be appropriate information reporting to have any significant impact on the tax gap.

The latest news is that two efforts to repeal it this week have failed. See a New York Times article of 11/29/10 by Carl Hulse, "Senators Cannot Agree on Fix to the Health Law."

It is also a bit comical perhaps in that there are arguably more pressing matters, such as what to do about the 72 provisions that expired in 2009 as well as the 2001/2003 tax cuts - all matters that greatly affect filing 2010 returns which starts in less than six weeks! The 1099 requirement doesn't start until 2012. Of course, given the challenge of finding revenue to cover repeal, it very well might need to be considered before renewing provisions that expired in 2009.

What a mess!

For more:

• 1099s - The Good, the Bad and the Ugly, AICPA Corporate Taxation Insider, 11/11/10
• Blog post of 11/19/10

1099s - The Good, the Bad and the Ugly

Well, need I say more than that title? Information reporting forms are certainly a useful compliance tool, but perhaps not for everything. Having a small business issue 1099s for these purchases starting in 2012 would be pointless:

• $852 of office supplies purchased from Staples
• $2,592 of airline tickets purchased directly from the airlines
• $1,300 of services from their CPA firm

Issuing a 1099 for $700 of services rendered by a web designer makes sense though and existing law already covers that.

Where is the line between an action that improves compliance without causing unnecessary costs and burdens to reporters?

What are better steps to take to reach the taxpayers with the poorest compliance?

I've got a short article in this week's AICPA Corporate Taxation Insider on 1099s noting the problems with recent changes to greater use and alternatives - 1099s - The Good, the Bad and the Ugly.

What do you think?

The Slow Approach to Closing the Tax Gap

The federal tax gap is about $345 billion per year! Reasons for this gap has been studied by the IRS, GAO and others for decades. Many proposals have been made, yet few have been enacted. President Bush's 2009 budget proposal included 16 tax compliance proposals. Some of these have been inserted into tax bills as revenue generators. For example, the proposal to require brokers to include stock basis information on 1099s has been included in a few bills, but not yet enacted.

I call this the "slow approach" to reducing the tax gap: Study it continuously, generate lots of ideas for reducing the gap, but avoid comprehensive legislation with a plan for reducing it. Political and budget reasons seem to be the cause for the slow approach. PAYGO has many benefits, but one of them doesn't seem to be to enact legislation that only raises revenue (no new tax breaks). So, we see tax gap proposals come to the table only when revenue is needed to pay for new or extended tax breaks.

The recently enacted housing bill is an example. It includes a requirement, effective for 2011, for credit and debit card payment processors, as well as online processors, such as PayPal, to issue 1099s noting the gross amount processed for merchants. This proposal has been in President Bush's budget proposal for the past few years, although calling for IRS regulations rather than a statutory change. The Joint Committee on Taxation estimates that this new reporting requirement will generate over $9 billion over 10 years. That seems like a lot given that unlike cash transactions, there is an audit trail for credit and debit card transactions. I'm guessing that a lot of the revenue estimate stems from online sellers who are not reporting sales despite transaction and activity levels that indicate they are operating a business.

One concern I have is with the long lead time until this new reporting provision is effective (2011). While this lead time is likely due to the need to allow reporters to get their systems capable of filing the 1099s, it also means the many people who don't like this provision have plenty of time to encourage Congress to repeal it.

For more information on the new reporting requirement and the tax gap, please see my short article in the AICPA Tax Insider for 8/14/08. It has more links to information mentioned above.