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|  Re: Question for Accountants on tha house...1099
This pretty much covers it! Sorry for the long post.
Key Issue 26A: Overview of Form 1099-MISC Reporting Requirements.
When a person engaged in a trade or business pays wages to an employee, the payer/employer must withhold income and FICA taxes (see Key Issues 15A and 15D) and file an annual Form W-2 for that person (see Key Issue 24A). However, these withholding and reporting requirements do not apply to nonemployees—that is, they do not apply to payments made to persons treated as independent contractors. Rather, payments for services rendered by independent contractors fall under the general rules for reporting payments of $600 or more made in the course of the payer’s trade or business.
Observation: Generally, any withheld income tax reported on a Form 1099-MISC is also reported on Form 945 (Annual Return of Withheld Federal Income Tax), which is discussed in Key Issue 22B. Withheld income tax reported on Form W-2 is reported on Form 941 (Employer’s Quarterly Federal Tax Return) or Form 944 (Employer’s Annual Federal Tax Return), which are discussed in Key Issues 20A and 20E.
Two separate Code sections require a person engaged in a trade or business to file an information return if payments during the year to an independent contractor for services provided total $600 or more. Under IRC Sec. 6041(a), a person who, in the course of a trade or business, makes fixed or determinable payments of salaries, wages, commissions, fees, and other forms of compensation for services rendered aggregating $600 or more must file an information return for that year. Similarly, pursuant to IRC Sec. 6041A(a), payments of $600 or more made in the course of a trade or business to service providers who are not employees must be reported.
Form 1099-MISC (Miscellaneous Income) is used to report payments to independent contractors who provide trade or business services. (See Table T301 for other forms in the 1099 series.) Specifically, it is used to report amounts paid as nonemployee compensation, including fees, commissions, prizes, awards, or other forms of compensation for services rendered to the payer’s trade or business by someone who is not an employee.
Caution: In an effort to narrow the annual tax gap (the difference between what taxpayers should pay and what they do pay on a timely basis), the IRS is focusing on worker classification issues as a means to collect funds. The IRS has indicated that it will target for examination businesses that issue five or more Forms 1099-MISC for $25,000 or more to workers who have no other income source shown on their individual income tax returns. See Key Issue 5A for a discussion on worker classification.
Examples of other types of payments reportable on Form 1099-MISC include (1) accrued wages and vacation paid to a deceased employee’s estate or beneficiary, (2) fees paid to corporate directors, (3) items subject to backup withholding (see Key Issue 16E), (4) direct sales of $5,000 or more of consumer products for resale anywhere other than a permanent retail establishment, (5) golden parachute payments [defined in IRC Sec. 280G(b)] to nonemployees, and (6) gross proceeds paid to an attorney in connection with legal services. See discussion later in this key issue for a detailed list of payments reportable on Form 1099-MISC.
Section 530 Relief
As discussed in Key Issue 8A, compliance with certain requirements enables a business to avoid the wage withholding requirements that apply to compensation paid to certain workers. This relief (referred to as Section 530 relief since the rules were enacted in Section 530 of the 1978 Revenue Act) allows a business to treat an employee as an independent contractor for wage withholding purposes if, in part, all required federal tax returns are filed by the business on a basis consistent with its treatment of the individual as a nonemployee. Therefore, to obtain Section 530 relief, the business must have filed Form 1099 (not Form W-2) for any worker who was paid $600 or more during the calendar year (Rev. Proc. 85-18).
Form 1099-MISC should be used to report nonwage payments, not to correct prior payments that were improperly handled. For example, assume a business treated its workers throughout the year as independent contractors rather than employees, and thus failed to withhold income or employment taxes or file quarterly employment tax returns. However, near the end of the year it determines the workers should have been treated as employees. Rather than issue a Form 1099-MISC to the workers, the business should correct the prior under withholding and file the required quarterly employment tax returns.
Entities Required to File Form 1099-MISC
The Form 1099-MISC reporting rules apply to any business (whether a sole proprietorship, partnership, or corporation) that makes a reportable payment in the course of its trade or business. Personal payments are not reportable. A payer is engaged in a trade or business if the payer operates for gain or profit.
Although they do not operate for gain or profit, nonprofit organizations are considered to be engaged in a trade or business and are subject to the Form 1099-MISC reporting requirements [Reg. 1.6041-1(b)(1)]. Nonprofit organizations subject to the Form 1099-MISC reporting requirements include trusts of qualified pension or profit-sharing plans of employers, certain organizations exempt from tax under IRC Sec. 501(c) or (d), and farmers’ cooperatives that are exempt from tax under IRC Sec. 521. Furthermore, governmental units (federal, state, or local), or any agency or subdivision thereof, are subject to these reporting requirements. The information return is prepared by the governmental unit officer or employee with control over the payment (or any other person appropriately designated to make the return) [IRC Sec. 6041A(d)].
Middlemen. A middleman makes payments on behalf of another person who is the actual source of the funds. Under certain circumstances, the middleman (and not the person who is the actual source of the funds) must report these payments to the payee on Form 1099-MISC. A middleman who performs a management or oversight function in connection with payments or has a significant economic interest in payments made on behalf of another person is the payer that must file Form 1099-MISC [Reg. 1.6041-1(e)]. If two or more people meet these requirements for the same payment, the person obligated to file Form 1099-MISC is the person closest in the chain to the payee (unless the parties agree in writing that someone else will make the filing).
However, an employee acting in the course of his or her employment who makes a payment to the employer on behalf of another person is not required to file a Form 1099-MISC for that payment. For example, a CPA, employed by Firm X and receiving direct payment from a client for accounting services, does not have to file a Form 1099-MISC if he or she remits the payment to the Firm as required by the CPA’s terms of employment.
A management or oversight function is an activity that is more than merely administrative or ministerial [Reg. 1.6041-1(e)(1)(i)]. For example, a middleman who writes checks at the direction of the person who is the actual source of the funds, is performing an administrative or ministerial function. Therefore, the middleman is not required to file Form 1099-MISC. Alternatively, a middleman who exercises discretion or supervision in connection with a payment is performing a management or oversight function. In this case, the middleman is required to file Form 1099-MISC.
A significant economic interest in a payment is an economic interest that would be compromised if the payment were not made [Reg. 1.6041-1(e)(1)(ii)]. For example, a bank has a significant economic interest in payments made to a contractor to repair damage on property securing a mortgage held by the bank. Therefore, the bank is required to file a Form 1099-MISC for these payments. However, a settlement agent who makes disbursements from an escrow account based on the verbal instructions of the seller or purchaser does not have a significant economic interest in the payments. In this situation, the settlement agent is not required to file Form 1099-MISC.
The determination of whether a person performs management or oversight functions with respect to a payment made on behalf of another, or has a significant economic interest in connection with such payment, is a factual one that should be determined in each instance based on facts and circumstances. The regulations provide numerous examples to demonstrate management and oversight functions and significant economic interests.
Payments Reportable on Form 1099-MISC
Form 1099-MISC is used to report fees, commissions, and other forms of compensation paid for services performed by partnerships and individuals who are not employees. Payments to corporations (including S corporations) need not be reported unless the payments are—
1. Medical and health care payments. (See discussion in Key Issue 26B.)
2. Fish purchases for cash. (See discussion later in this key issue.)
3. Attorney’s fees. (See discussion later in this key issue.)
4. Gross proceeds paid to an attorney. (See discussion later in this key issue.)
5. Payments by a federal executive agency to vendors for services. These amounts are reported in box 7. [Form 8596 (Information Return for Federal Contracts) and Form 8596-A (Quarterly Transmittal of Information Returns for Federal Contracts) may also be required if the contracted amount for personal services is more than $25,000.]
6. Substitute payments in lieu of dividends or tax-exempt interest. (See box 8 discussion in Key Issue 26B.)
Only payments made in the course of the payer’s trade or business are reportable. Therefore, a payment by a sole proprietor to a doctor for medical services provided to the proprietor’s child need not be reported.
Payments Must Be Fixed and Determinable. Payments are not required to be reported on Form 1099-MISC unless they are fixed or determinable. Income is fixed if it is payable in definitely predetermined amounts and is determinable if there is a basis by which it can be calculated [Reg. 1.6041-1(c)]. The income does not need to be paid annually or at regular intervals. Additionally, income is determinable even if it may be increased or decreased, depending on the happening of an event (e.g., commissions based on sales).
IRS regulations clarify how to report a payment made jointly to two or more payees that is not fixed and determinable income for all payees [Reg. 1.6041-1(c)]. For example, property insurance proceeds paid jointly to the owner of damaged property and to a contractor that repairs the property may be fixed and determinable income to the contractor but not fixed and determinable income to the owner. In this case, Form 1099 must be filed only for the payee for whom the payment is fixed and determinable income (i.e., the contractor).
Payments Other than Cash. A payment in a form other than money (e.g., property or services) should be reported at the property’s or service’s FMV on the date of the payment [Reg. 1.6041-1(g)]. A payment is deemed made when credited or set aside with no substantial limitation as to the time or manner of receipt. This means the payment must be made available to the payee and be within the payee’s control [Reg. 1.6041-1(h)].
Example 26A-1: Reporting a payment in property rather than cash.
Mrs. Green was the top (nonemployee) commission salesperson for Tipps, Inc. for the current year, and for her efforts was awarded a gold watch. Tipps must report the FMV of the watch on a Form 1099-MISC issued to Mrs. Green. Since the FMV of the watch may not be easy to determine, Tipps can use the manufacturer’s suggested retail selling price in preparing the Form 1099-MISC (Rev. Rul. 58-347).
Amount to Be Reported. The amount to be reported as paid to a payee is the amount includible in the payee’s gross income [Reg. 1.6041-1(f)]. Often, this will be the gross amount of the payment(s) before fees, commissions, expenses, or other amounts owed by the payee to another person have been deducted. This applies whether the payment is made jointly or separately to the payee and another person.
Attorney Fees Included in a Settlement Award. There was conflicting case law on the issue of whether attorneys fees included in a settlement or damage award are income to the client-payee. In 2005, the Supreme Court settled the matter by holding that, under the assignment of income principle, the entire amount of the settlement was includible in the client-payee’s gross income, including the portion paid to an attorney as a contingent fee. In addition, the American Jobs Creation Act of 2004 resolved the matter going forward by providing for a deduction against settlement income for attorney fees and court costs paid by or on behalf of the client-payee. This above-the-line deduction applies to fees paid after October 22, 2004 for settlements occurring after that date. The deduction is allowed even if the attorney fees are paid on a contingent basis. The above-the-line deduction is, however, limited to the amount of the settlement that is includible in the client-payee’s income for the year.
Example 26A-2: Reporting the gross amount of a payment.
Pat Bell, an attorney, represents independent contractor Jane Smith in a breach of contract action for lost profits against Burke, Inc. Burke settles the case for $100,000 damages and $40,000 for attorney fees. Under applicable law, Jane is required to include the full $140,000 in income. Burke issues a check payable to Pat and Jane in the amount of $140,000. Burke is required to report the $140,000 payment to Jane on Form 1099-MISC. Under the rules requiring the reporting of gross proceeds paid to an attorney (see discussion later in this key issue), Burke is also required to issue a Form 1099-MISC to Pat for $140,000.
Variation: Assume Burke issues a check to Jane for $100,000 and a separate check to Pat for $40,000. Burke is still required to report the $140,000 payment to Jane on Form 1099-MISC. Under the rules requiring the reporting of gross proceeds paid to an attorney (see discussion later in this key issue), Burke is also required to issue a Form 1099-MISC to Pat for $40,000.
Note: In both variations Jane must issue a Form 1099-MISC to Pat for $40,000 since the fee is for services performed in connection with Jane’s trade or business. Jane will be able to deduct the $40,000 paid to Pat.
Nonemployee Compensation
Nonemployee compensation (including fees, commissions, prizes, awards, and other forms of compensation for services rendered to a trade or business) is reported in box 7, “Nonemployee Compensation,” of Form 1099-MISC. If the following conditions are met, the payment generally is reportable as nonemployee compensation:
1. The payment was made to a nonemployee.
2. The payment was made for services rendered to or on behalf of the payer’s (including government agencies and nonprofit organizations) trade or business.
3. The payment was made to an individual, partnership, estate, or in some cases, a corporation. (See previous discussion in this key issue regarding which payments to corporations must be reported.)
4. Payment(s) to the payee totaled $600 or more during the year (including payment for parts or materials used by the payee in rendering the services if supplying the parts or materials was incidental to providing the service). However, if federal income tax was withheld under the backup withholding rules, Form 1099-MISC must be filed regardless of the amount of the payment (i.e., even if the payment was less than $600).
Example 26A-3: Reporting a payment by a tax-exempt entity.
Mr. Jones, the self-employed owner of an unincorporated home repair business, is paid $1,000 during the year for repair work on a church. Even though the church is exempt from federal income tax, the payment meets the preceding four requirements for reporting, and therefore the church must issue a Form 1099-MISC for $1,000 to Mr. Jones.
Payments Reportable as Nonemployee Compensation
Examples of payments that must be reported in box 7 as nonemployee compensation include:
1. Fees paid for professional services such as fees paid to attorneys (including corporations), accountants, architects, contractors, and engineers. (See the discussion on reporting gross proceeds payments to attorneys later in this key issue.)
2. Fees paid by one professional to another, such as fee-splitting or referral fees.
3. Payments by attorneys to witnesses or experts in legal adjudication.
4. Payments for services, including payment for parts or materials used to render the services if supplying the parts or materials is incidental to providing the service. For example, the total insurance company payments to an auto repair shop for a repair contract showing separate amounts for labor and parts are reported if furnishing parts was incidental to repairing the auto.
5. Commissions to nonemployee salespersons that are subject to repayment but not repaid during the calendar year.
6. A fee paid to a nonemployee, including an independent contractor, or travel reimbursement that the nonemployee did not account to the payer (see Key Issue 13A), if the fee and reimbursement total at least $600.
7. Payments to nonemployee entertainers for services rendered. However, payers use Form 1042-S (Foreign Person’s U.S. Source Income Subject to Withholding) for such payments to nonresident aliens.
8. Exchanges of services between individuals in the course of their trades or businesses. For example, if an attorney represents a painter for nonpayment of business debts in exchange for the painting of the attorney’s law offices, the amount reported by each on Form 1099-MISC is the FMV of his or her own services performed. However, if the attorney represents the painter in a divorce proceeding, the divorce is an activity that is unrelated to the painter’s trade or business. Therefore, the attorney reports the FMV of his or her services on Form 1099-MISC, but the painter does not report the value of painting the law offices on Form 1099-MISC because the work is in exchange for legal services that are separate from the painter’s business.
9. Taxable fringe benefits provided to nonemployees.
10. Gross oil and gas payments for a working interest.
11. Payments of director’s fees and other remuneration to members of the board of directors, including payments made after retirement.
12. Payments to an insurance salesperson who is not a common law or statutory employee. (See Key Issues 6A and 7A.) However, see discussion later in this key issue for information on reporting termination payments to formerly self-employed insurance salespeople.
13. Commissions paid to licensed lottery ticket sales agents.
14. If purchasing fish for resale, fish purchases for cash. (See the discussion later in this key issue.)
15. Golden parachute payments made to nonemployees. If any portion of the golden parachute payment is an excess golden parachute payment, the excess is also reported in box 13. (See Key Issue 24B for an explanation of golden parachute payments.)
16. Expenses incurred for the use of an entertainment facility that is treated as compensation to nonemployees.
17. Payments to Section 530 employees. (See discussion earlier in this key issue.)
Nonqualified Deferred Compensation to a Nonemployee (Section 409A). The amount of all deferred compensation, plus earnings, that is includible in gross income because the nonqualified deferred compensation plan failed to meet the requirements of IRC Sec. 409A is reported on Form 1099-MISC in box 7. The recognition of income does not require that a payment be made to the nonemployee in the current year. Amounts previously included in income are not reported. The amount includible in box 7 is the amount reported in box 15b. This income is generally subject to self-employment tax and a substantial additional tax reported on the nonemployee’s Form 1040. (See the discussion in Key Issue 10F for more information on IRC Sec. 409A.)
Transit Passes and Parking for Independent Contractors. Although qualified transportation fringe benefits (see Key Issue 10L) cannot be provided to independent contractors, the de minimis fringe benefit rules for transit passes and parking apply to independent contractors. Tokens or farecards that enable an independent contractor to commute on a public transit system (not including privately operated van pools) are excludable from the independent contractor’s gross income and are not reportable on Form 1099-MISC if their value in any month is $21 or less [Reg. 1.132-6(d)]. However, if the value of a pass provided in a month is greater than $21, the full value is includible in gross income and is reportable on Form 1099-MISC in box 7. The value of free or reduced-cost parking may be excludable from an independent contractor’s gross income, and, therefore, not reportable on Form 1099-MISC, if the parking qualifies as a de minimis fringe benefit (IRS Notice 94-3). (See Key Issue 10Q for information on de minimis fringe benefits.)
Payments to Attorneys. Attorneys’ fees of $600 or more paid in the course of a trade or business for legal services are reportable in box 7 of Form 1099-MISC. Additionally, IRC Sec. 6045(f) requires information reporting for gross proceeds made in the course of a trade or business to attorneys in connection with legal services. Legal services refer to all services related to, or supportive of, the practice of law performed by, or under supervision of, an attorney [Reg. 1.6045-5(d)(2)]. An attorney is a person engaged in the practice of law, whether as a sole proprietor, partnership, corporation, or joint venture [Reg. 1.6045-5(d)(1)]. Payments to attorneys for legal services are reportable payments and, therefore, subject to the backup withholding requirements.
If a payment is made to an attorney in connection with legal services and the attorney’s fees are not reportable in box 7, the total amount paid to the attorney (i.e., the gross proceeds) must be reported in box 14. This rule applies whether or not the legal services are provided to the payer or the attorney is the exclusive payee (e.g., applies even if the attorney’s and claimant’s names are on one check) or other information returns are required for some or all of a payment under IRC Sec. 6041(a).
Example 26A-4: Reporting payment to an attorney.
Insurance company URC pays the legal firm of Cave, Dean, and Cooke, LLC, $200,000 to settle a claim. Assume the settlement payment does not meet the Form 1099-MISC reporting requirements under IRC Sec. 6041(a) (i.e., it is not a trade or business payment by URC of $600 or more for salaries, wages, commissions, fees, or other form of compensation). Nonetheless, the settlement payment does meet the gross proceeds paid to an attorney requirement under IRC Sec. 6045(f) and therefore must be reported by URC in box 14 of Form 1099-MISC.
The exemption from issuing Forms 1099-MISC to corporations that was discussed earlier in this key issue, does not apply to payments for legal services. Therefore, attorney’s fees or gross proceeds paid to corporations that provide legal services must be reported on Form 1099-MISC in box 7 or box 14, respectively. Payers may file either one Form 1099-MISC aggregating annual payments for individual payees or separate Forms 1099-MISC for each payment.
A payer is a person who makes a payment if that person is an obligor on the payment or the obligor’s insurer or guarantor [Reg. 1.6045-5(d)(3)]. For example, a payer is a person who pays a settlement amount to an attorney of a client who has asserted a tort or contract claim against that person. Furthermore, if the person’s insurer pays the settlement amount to the attorney, the insurer is a payer.
Payments to an attorney include payments by check or other method such as cash, wire, or electronic transfer. Payment by check to an attorney is a check on which an attorney is named as a sole, joint, or alternative payee [Reg. 1.6045-5(d)(4)]. The attorney is the payee on a check written to the attorney’s client trust fund. However, the attorney is not a payee when the check is written to the client “in care of” the attorney or if the attorney’s name is included on the check in such a way that the attorney cannot negotiate it.
If a settlement payment for which information returns are required under both IRC Sec. 6041(a) and another Code section (e.g., IRC Sec. 6045) is for the same payee, then only one information return should be filed [IRC Sec. 6045(f)(2); Reg. 1.6041-1(a)(1)(iii)]. However, if the payees are different, more than one information return is required. For example, a company that settles a claim by issuing a check for $600 payable to the claimant’s attorney may be required to file a Form 1099-MISC under IRC Sec. 6041 for the claimant and another Form 1099-MISC under IRC Sec. 6045(f) for the claimant’s attorney.
Example 26A-5: Settlement taxable to claimant.
Sam sued his former employer, Petersen Industries, for back wages. Petersen settled the suit for $300,000. (The full amount is taxable to Sam as wages.) A $200,000 check ($300,000 less income and FICA tax withholding), payable jointly to Sam and his attorney, Taylor McBride, is given to Taylor. Taylor keeps $75,000 of the payment as compensation for legal services and disburses the remaining $125,000 to Sam.
Petersen must issue an information return to Taylor for $200,000 (reported in box 14 of Form 1099-MISC). In addition, under IRC Sec. 6051, Petersen must report $300,000 on a Form W-2 for Sam.
Example 26A-6: Settlement not taxable to claimant.
Joyce sues BigMart for damages resulting from personal injuries suffered while in a BigMart store. BigMart settles the suit with a $600,000 damages payment that is excludable from Joyce’s income under IRC Sec. 104(a)(2). BigMart writes the settlement check payable jointly to Joyce and her attorney, Clark. The check is delivered to Clark, who retains $240,000 as attorney fees and remits the remaining amount ($360,000) to Joyce. BigMart must file an information return with respect to Clark for $600,000 (reported in box 14 of Form 1099-MISC). Bigmart is not required to file a Form 1099-MISC for the tax-free damages paid to Joyce.
If more than one attorney is listed as a payee on a check, the information return is required to be filed with respect to the attorney who received the check. Additionally, if at least one attorney is listed as a payee on a check and the check is delivered to a payee who is not an attorney, the information return must be filed with respect to the first-listed payee attorney on the check. Finally, if two or more attorneys are listed as payees on a check and the check is delivered to a nonpayee, then the information return must be filed with respect to the first-listed payee attorney on the check.
Example 26A-7: Multiple attorneys listed as payee.
Fellows Corporation settles a suit brought by Matt Grayson by paying a check for $1 million to Matt’s three attorneys, Adam, Zeke, and Charles. Adam, Zeke, and Charles do not belong to the same law firm. The check is delivered to Zeke, who deposits the check into a trust account and makes payments by separate checks to Adam for $100,000 and to Charles for $50,000 for their share of the attorney fees. Zeke also makes a payment of $550,000 to Matt.
Fellows must file an information return (Form 1099-MISC, box 14) for $1 million with respect to Zeke, who in turn must file a Form 1099-MISC with respect to Adam (for $100,000) and Charles (for $50,000). Zeke should report the amounts paid to Adam and Charles in box 7 of Form 1099-MISC (assuming they were working for him as outside legal consultants). Depending on the nature of the lawsuit, Fellows presumably also would need to file a Form 1099-MISC with respect to Matt.
Now assume that Fellows makes the check payable to Matt, but still delivers it to Zeke. Here, Fellows is not required to file an information return with respect to Zeke because there was no payment to an attorney as defined in IRC Sec. 6045(f) [Reg. 1.6045-5(f), Ex. 4].
Reporting is not required by IRC Sec. 6045(f) (although as noted, reporting may be required under another provision) when [Reg. 1.6045-5(c)]:
• Wages or other compensation is paid to an attorney by the attorney’s employer. (A Form W-2 is required instead.)
• Compensation or profits are paid or distributed to partners by a partnership or LLC engaged in providing legal services. (Instead, the partners or members should receive a Schedule K-1 from the entity.)
• Dividends or corporate earnings and profits are paid to shareholders by a corporation engaged in providing legal services. (A Form 1099-DIV will be required if the annual total is at least $10.)
• Payments are made to an attorney reportable under IRC Sec. 6041(a) (or payments that would be reportable if they totaled at least $600 for the year) for rents, premiums, annuities, or other fixed or determinable amounts. In other words, payments for an attorney’s services that are reportable in box 7 of Form 1099-MISC [as required by IRC Sec. 6041(a)] are not reportable in box 14 of Form 1099-MISC.
• Payments are made to a nonresident alien individual, foreign partnership, or foreign corporation that is not engaged in a U.S. trade or business and does not perform any labor or personal services in the U.S.
• Payments are made to an attorney as the settlement agent in a real estate transaction.
• Payments are made to an attorney in the attorney’s capacity as a trustee in bankruptcy.
To summarize, almost any payment made to an attorney in the course of the payer’s trade or business is reportable if total payments to a single payee are $600 or more during the year. Payments for services belong in box 7 of Form 1099-MISC, while other payments (such as in settlement of a lawsuit) belong in box 14.
Fish Purchases for Cash. Persons in the trade or business of purchasing fish for resale must report total cash payments of $600 or more paid during the year to any person who is engaged in the trade or business of catching fish. These payments are reported in box 7. Records must be kept showing the date and amount of each cash payment made during the year, but only the total amount paid for the year is reported on Form 1099-MISC.
Fish means all fish and other forms of aquatic life. Cash means (1) U.S. and foreign coin and currency and (2) a cashier’s check, bank draft, traveler’s check, or money order. Cash does not include a check drawn on a personal or business account.
Below-market Compensation-related Loans. Under IRC Sec. 7872, the amount of forgone interest attributable to a below-market loan to an employee from an employer, or to an independent contractor from the party to whom services are provided, is treated as a payment of compensation to the employee or independent contractor. This payment is deemed to be immediately followed by an identical payment of interest by the employee or independent contractor to the employer or service recipient [Prop. Reg. 1.7872-4(c)].
Under the Committee Reports to the Deficit Reduction Act of 1984, this deemed payment of compensation is subject to applicable information reporting requirements [HR Rep. No. 861, 98th Cong., 2d Sess. 1018-19 (1984)]. Presumably, this means the deemed payment of compensation attributable to the below-market loan must be reported on Form W-2 if the loan is made to an employee, or in box 7, “Nonemployee Compensation,” of Form 1099-MISC if the loan is made to an independent contractor.
Note: See also Key Issue 26B for guidance on completing each box of the Form 1099-MISC.
Other Reportable Payments
Other income of at least $600 that is required to be reported on Form 1099-MISC that is not reportable in one of the other boxes on the form, is reported in box 3, “Other Income.” Some of the more common items reported in box 3 are discussed below. See also Key Issue 26B for guidance on completing each box of the Form 1099-MISC.
Deceased Employee’s Wages. If an employee dies during the year, the employer must report the accrued wages, vacation pay, and other compensation paid after the date of death. If payment is made in the same year the employee dies, the employer must withhold social security and Medicare (FICA) taxes from the payments and report the income on the employee’s Form W-2 in boxes 3 (subject to the maximum social security wage base) and 5 to ensure that proper credit is received for social security benefit purposes, but not in box 1. (See Key Issues 10D and 24B for more information.) Conversely, if payment is made after the year of death, the employer is not required to withhold FICA tax, and such amounts are not reported on Form W-2.
Whether made in the year of death or after the year of death, the employer must also report payments made to the deceased employee’s estate or beneficiary on Form 1099-MISC. Such payments are entered in box 3 rather than box 7, see Rev. Rul. 86-109. The employer should report the payment under the name and taxpayer identification number of the payment recipient, not the deceased employee. For example, if the recipient is an individual beneficiary, the employer should enter the name and social security number of the beneficiary on the Form 1099-MISC. The general backup withholding rules apply to the payment (see Key Issue 25E).
Observation: Death benefits from qualified and nonqualified deferred compensation plans paid to the estate or beneficiary of a deceased employee are reported on Form 1099-R, not on Form 1099-MISC. (See Key Issue 26D.)
Example 26A-8: Reporting a deceased employee’s accrued wages and vacation pay.
Before his death on June 15, 2008, Ace Jones was employed by Bandage Co. and received $10,000 in wages from which $1,100 of income tax and the proper amount of FICA tax was withheld. When Ace died, the company owed him $2,000 in wages and $1,000 in accrued vacation pay, which was paid to Kay Jones, his surviving spouse, on July 19, 2008. Because the company made payment during the year of death, it must withhold FICA tax on the $3,000 payment and complete a Form W-2 in the decedent’s name. This Form W-2, along with Form 1099-MISC reporting the $3,000 paid to his surviving spouse, are reproduced in Illustration 26-1.
If Bandage Co. made the payment after the year of Ace’s death, the $3,000 would not be subject to FICA tax withholding and would not be reported on Form W-2. However, the payment still would be reported on Form 1099-MISC, completed the same as in Illustration 26-1.
Prizes and Awards. The FMV of prizes and awards that are not for services rendered (e.g., merchandise won on a game show) is reported in box 3 of Form 1099-MISC. Also included are amounts paid to a winner of a sweepstakes or tournament not involving a wager. If a tournament requires an entry fee, the amount of the prize that should be reported in box 3 of Form 1099-MISC is the prize net of the entry fee. However, an entry fee for a tournament in which a player did not win a prize should not be netted against the player’s winnings from other tournaments by the same sponsor during the year (see Ltr. Rul. 200532025). If a wager is made, the winnings are reported on Form W-2G (Certain Gambling Winnings). Wagers are considered to be made only if the activity is a lottery or wagering pool. The term wagering pool includes all pari-mutuel betting pools, including on-track and off-track racing pools and similar types of betting pools. In common usage, the term pool connotes a particular gambling practice, an arrangement whereby all bets constitute a common fund to be taken by the winner or winners (Rev. Proc. 2007-57).
Preparation Pointer: If, not later than 60 days after becoming entitled to the prize, the winner can choose the option of a lump sum or an annuity payable over at least 10 years, the payment of winnings is considered made when actually paid. If the winner chooses an annuity, Form 1099-MISC is filed each year to report the annuity paid during that year.
Prizes and awards received in recognition of past accomplishments in religious, charitable, scientific, artistic, educational, literary, or civic fields are not reportable if (1) the winners are chosen without action on their part, (2) the winners are not expected to perform future services, and (3) the payer transfers the prize or award to a charitable organization or governmental unit under a designation made by the recipient. See Rev. Proc. 87-54.
Prizes and awards for services performed by nonemployees (e.g., an award for the top commission salesperson) are reported in box 7 of Form 1099-MISC, while prizes and awards for employees are reported on Form W-2.
According to IRS Pub. 3204 (Automotive Manufacturers’ Incentive Program to Vehicle Salespersons), incentive payments paid by an automotive manufacturer, whether directly to individual salespersons or through a dealer, are reported in box 3 of Form 1099-MISC, not Form W-2, since such amounts are not wages subject to employment taxes or income tax withholding. Also, these payments are not considered to be self-employment income and therefore are not subject to self-employment tax. The recipient of a manufacturers incentive payment reports the income on the “Other income” line of his or her Form 1040 (U.S. Individual Income Tax Return).
Damages. Generally, all punitive damages and any damages for nonphysical injuries or sickness, such as employment discrimination, are reportable in box 3 of Form 1099-MISC. Nonpunitive damages should not be reported (1) if received on account of personal physical injuries or physical sickness; (2) to the extent the damages do not exceed the amount paid for medical care for emotional distress; or (3) if received on account of nonphysical injuries under a written binding agreement, court decree, or mediation award in effect on or issued by September 13, 1995. See Key Issue 10E for more on employee damage awards. Also report liquidated damages received under the Age Discrimination in Employment Act of 1967 in box 3.
Observation: Damages received from emotional distress, including physical symptoms such as insomnia, headaches, and stomach disorders, are not considered received for a physical injury or physical sickness and are reportable unless described in item (2) or (3) in the previous paragraph. However, damages received from emotional distress due to physical injuries or physical sickness are not reportable.
Preparation Pointer: Taxable back pay damages may be wages and reportable on Form W-2. See Key Issue 10E.
Juror’s Compensation. According to an IRS Legal Memorandum (ILM 199932004), payments made to jurors are reported on Form 1099-MISC, box 3, if payments equal or exceed $600. Since jurors are not employees, their compensation is not subject to FICA tax. Additionally, juror compensation is not subject to FITW or self-employment tax because it is in the nature of fees paid to public officials.
Compensation Paid to Employees on Military Leave Many employers provide supplemental military leave pay (also called differential pay) to employees who are active in a state National Guard or the U.S. Armed Forces Reserve. Some employers maintain a policy to continue paying at least a portion of regular wages, while others make up the difference between the employee’s regular wages and the military pay received from the state or U.S. government. The proper tax treatment of supplemental military leave pay depends on the duration of the employee’s military leave assignment (Rev. Rul. 73-187).
1. Temporary Duty. If the employee is on temporary duty for 30 days or less with the U.S. Armed Forces Reserve or a state National Guard (e.g., on leave for reserve training that generally lasts no more than two weeks per year), the employment relationship is not considered broken. Thus, supplemental military leave pay by the employer is taxable employee compensation subject to FITW, FICA, and FUTA and is reported on Form W-2 (Rev. Rul. 68-238).
2. Active Duty. If the employee enlists or is called up for active service with the U.S. Armed Forces or on an indefinite assignment (more than 30 days) with the state National Guard, the IRS considers the employment relationship terminated and the supplemental military leave pay by the employer is taxable nonemployee compensation not subject to income tax withholding, FICA, or FUTA and is reported in box 3 of Form 1099-MISC (Rev. Rul. 69-136).
Law Change: The Heroes Earnings Assistance and Relief Act of 2008 (HEART) changes the treatment of differential pay for federal income tax withholding (FITW) purposes. Differential payments made after 2008 will be subject to FITW and reported on Form W-2 [IRC Sec. 3401(h)]. However, the pay will not be subject to FICA or FUTA since HEART amended IRC Sec. 3401 (the FITW withholding section) but not IRC Secs. 3121 (the FICA section) and 3306 (the FUTA section). The pay will also qualify as compensation for retirement plan and IRA purposes. HEART defines differential pay as any payment that (1) is paid by an employer to an individual for any period that he or she is performing active duty military service for a period of more than 30 days, and (2) represents all or a portion of the wages the individual would have received from the employer if he or she was performing services for the employer [IRC Sec. 3401(h)(2)].
Termination Payments to Formerly Self-employed Insurance Salespeople. These payments are not subject to self-employment tax and are reportable in box 3 (rather than box 7) if all the following apply:
1. The payments are received from an insurance company because of services performed as an insurance salesperson for the company.
2. The payments are received after termination of the salesperson’s agreement to perform services for the company.
3. The salesperson did not perform any services for the company after termination and before the end of the year.
4. The salesperson enters into a covenant not to compete against the company for at least one year after the date of termination.
5. The amount of the payments depend primarily on policies sold by the salesperson or credited to the salesperson’s account during the last year of the service agreement or on the extent to which those policies remain in force for some period after termination, or both.
6. The amount of the payments does not depend at all on length of service or overall earnings from the company (regardless of whether eligibility for payment depends on length of service).
Note: If the termination payments do not meet these requirements, they are reported in box 7.
Direct Sales of $5,000 or More to a Buyer for Resale. A direct seller is someone who is engaged in the business of selling consumer products either (1) in a home or other nonpermanent retail establishment or (2) to a buyer for resale in a home or other nonpermanent retail establishment (another direct seller). Most direct sellers work out of their own homes and sell door-to-door, through a sales party plan, or by appointment in someone else’s house.
When one direct seller who has other direct sellers working under him or her sells $5,000 or more in goods during the year to any one of those other direct sellers, he or she must report the sales on Form 1099-MISC. The return must include the name, address, and identification number of the seller placing the orders; however, a dollar amount is not reported. Box 9 of Form 1099-MISC is checked (see box 9 discussion in Key Issue 26B ). For more information on direct sellers, see Key Issue 7D.
Certain Transfers Incident to Divorce. When interests in nonstatutory stock options and nonqualified deferred compensation are transferred from an employee spouse to his or her nonemployee spouse incident to divorce, the income recognized by the nonemployee spouse upon the exercise of the nonstatutory stock options and distributions received by the nonemployee spouse from the nonqualified deferred compensation plan are reported on Form 1099-MISC, in box 3 using the name, address, and social security number of the nonemployee spouse (Rev. Rul. 2004-60). See Key Issues 10F and 10H for additional information on transfers incident to divorce.
Payments Not Required to Be Reported on Form 1099-MISC
Some payments are not required to be reported on Form 1099-MISC, although they may be taxable to the recipient. Payments for which a Form 1099-MISC is not required include:
1. Payments to a corporation, although there are exceptions as previously discussed in this key issue.
2. Payments to a tax-exempt organization, the United States, a state, the District of Columbia, a U.S. possession, or a foreign government.
3. Wages or bonuses paid to employees (which are reported instead on Form W-2).
4. Employee business expense reimbursements or auto and travel allowances provided to employees (which as noted in Key Issues 13B, 13E, and 13G may be reportable on Form W-2).
5. Group-term life insurance paid on behalf of a former employee, which is reported instead on Form W-2 (see Key Issue 12L ).
6. Payments for merchandise, including inventory, telegram, telephone, freight, storage, and similar charges.
7. Payments of rent made by tenants to real estate agents. However, the agent must file a Form 1099-MISC for payments to the landlord if the amount paid during the year is at least $600.
8. Costs of current life insurance protection, which are reported instead on Form 1099-R (see Key Issue 26C) or Form W-2 (see Key Issue 24B).
9. Scholarship or fellowship grants. Scholarship or fellowship grants that are taxable to the recipient because they are paid for teaching, research, or other services as a condition for receiving the grant are considered wages and must be reported on Form W-2. Other taxable scholarship or fellowship payments are not reported to the IRS on any form. See IRS Notice 87-31.
10. Cancelled debts are not reported on Form 1099-MISC. Financial institutions, federal government agencies, certain agencies connected with the federal government, and entities that lend money as a significant trade or business are required to report canceled debts, but must do so on Form 1099-C (Cancellation of Debt) not Form 1099-MISC (IRC Sec. 6050P).
11. Generally, payments that are not includible in the recipient’s income are not reported on Form 1099-MISC. For example, payments made for personal injuries or sickness under worker’s compensation acts are not reported on Form 1099-MISC, because those payments generally are excluded from gross income under IRC Sec. 104(a)(1) (ILM 199938032 and Ltr. Rul. 200226018). Similarly, damages (other than punitive damages) received from a lawsuit for physical personal injuries are not reported to the plaintiff on Form 1099-MISC because the settlement is excluded from the plaintiff’s income under IRC Sec. 104(a)(2) [Reg. 1.6045-5(f), Ex. (2)]. However, a Form 1099-MISC does have to be filed reporting any gross proceeds paid to an attorney. See the discussions earlier in this key issue for more information on reporting damages and payments to an attorney.
12. Certain payment card transactions are not subject to reporting if a payment card organization has assigned a merchant/payee a Merchant Category Code (MCC) indicating that reporting is not required. A cardholder/payer may rely on the MCC that the payment card organization assigned to a merchant/payee to determine if a payment card transaction with that merchant/payee is subject to information reporting (Rev. Proc. 2004-43). See Key Issue 16G for more information.
Law Change: In 2007, the IRS issued proposed regulations and a proposed revenue procedure that would revise the rules for payment card transactions [Prop. Reg. 31.3406(g)-1(f); IRS Notice 2007-59]. The new rules have not been finalized. See Key Issue 16G for information on these rules.
Bankruptcy Cases
The bankruptcy estate of a Chapter 11 debtor who is an individual is a separate taxable entity. Therefore, a debtor’s gross earnings from services performed after the commencement of the bankruptcy case (i.e., post-petition services) are generally included in the bankruptcy estate’s gross income, rather than in the debtor’s gross income. Within a reasonable time after the commencement of a Chapter 11 bankruptcy case, the debtor (or trustee) must provide the bankruptcy estate’s EIN to payers required to report the debtor’s nonemployee compensation on Form 1099-MISC. These payers should report these payments on Form 1099-MISC using the bankruptcy estate’s name and EIN. If payers filing Form 1099-MISC improperly report payments to the debtor that should have been reported to the bankruptcy estate, the debtor (or trustee) must allocate the improperly reported income in a reasonable manner between the debtor and the estate (IRS Notice 2006-83). For discussion of income reported on Form W-2, see Key Issue 2B.
If a Chapter 11 case is converted to a Chapter 7 or Chapter 13 case the above rules do not apply, and earnings from post-conversion services are taxed to the debtor rather than the bankruptcy estate. After a debtor’s Chapter 11 case is converted, the debtor should notify payers required to report the debtor’s nonemployee compensation on Form 1099-MISC that such compensation earned after the conversion should be reported using the debtor’s name and taxpayer identification number, rather than the estate’s name and EIN.
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Tom
31' Jupiter |
