By:  Richard Repose

Former IRS Employment Tax Specialist

Many businesses fail to review their bank account check registers and accounts payable journal ledgers for service providers and others who require the preparation and filing of a Form 1099-MISC.  This can be a costly mistake if the IRS conducts an audit.

The Internal Revenue Code sections 6041 and 6041A require certain payors who make payments of $600 or more annually to payees for services provided to prepare and file an information tax return.  All persons engaged in a trade or business and making payments in the course of a trade or business to another person for rent, salaries, wages and most other types of services that a going business needs may require the filing of a Form 1099-MISC.  Employees’ wages are reported on a Form W-2.  The Code also requires that the payor furnish the payee with a copy of the Form 1099 by January 31st of the year following the year in which payments were made.  The original Form 1099 must be filed with the IRS by the last day in February of the same year.  IRC sections 6721 and 6722 provide for the imposition of penalties of $50 for each return that is not timely filed and $50 for each return that is not timely furnished to the payee.  Penalties can be waived if the payor has reasonable cause.

According to Treasury Regulation 1.6041-1, payments specifically included are amounts paid in respect of life insurance, endowment or annuity contracts of $600 or more.  These payments are required to be reported on information returns.  Also included under this requirement, but not limited to, are payments of professional fees, prizes and awards, most contracts for services, and payments made on behalf of another person.  The amount to be reported on the Form 1099 is the amount includible in the gross income of the payee.  Generally, this will be the gross amount of the payment before fees, commissions, expenses or other amounts owed by the payee have been deducted.

Should any payments made by a payee in the conduct of a trade or business be considered legally as wages, the payee must report the wages and any taxes withheld on a Form W-2 and not a Form 1099.  Only in rare circumstances would an employee whose wages are reported on a Form W-2 receive a Form 1099 for other types of compensation paid.  An employee, generally, is a worker who is under the direction and control of an employer.

Treasury Regulation 1.6041-3 specifies the types of payments for which no information tax return is required.  Some of these payments include bills for merchandise, telegrams, telephones, freight, storage and similar charges.  Payments of rent made to rental agents, compensation and profits paid or distributed to partners of a partnership,  substantiated business and travel expenses paid under an accountable plan do not require an information tax return.  Payments made to a corporation, except for a corporation engaged in providing or billing and collecting medical and health care services do require an information tax return.  Payments made to a hospital or extended care facility that is tax exempt do not require an information tax return.  Another exception is where payment of attorneys’ fees is made to a corporation.  An information tax return is required if the annual amount paid is $600 or more.  

Persons engaged in a trade or business who fail to timely file and to timely furnish an information tax return to a payee required under the law not only face liability for civil penalties so described in this article.  Those persons may also face a backup withholding tax liability described in IRC section 3406.  In the case of any reportable payment where the payee fails to furnish his taxpayer identification number (TIN) or the IRS notifies the payor that theTIN furnished by the payee is incorrect backup withholding taxes do apply. The payor is required to deduct backup withholding taxes before making payment of the obligation to the payee.  The total payment due must equal or exceed $600 annually to require the deduction of such a tax.  Backup withholding taxes are reported by the payor annually on a Form 945.  Deposits or payments of these taxes is similar to the requirements for Forms 941 and 940 taxes.  Should the payee fail to provide his TIN and if the payor fails to deduct the proper backup withholding taxes, the payor is liable for payment of the taxes.  This also applies when the IRS notifies the payor that the TIN of the payee is incorrect.  The liability for payment of backup withholding taxes is set forth in IRC section 3403.  The tax rate is presently 28% of the payment due. The IRS strongly suggests the use of the Form W-9 to obtain payees’ TINs and the form of business.

Although IRC 3402(d) provides for relief from income tax withholding and backup withholding taxes, the effort required by the payor to obtain such relief is very significant and requires an expenditure of time.  Also any interest or penalties that accrue on an unpaid and assessed backup withholding tax liability is not subject to the relief provisions and must be paid by the payor.

Congress and the President enacted these laws with the Tax Reform Act of 1986.  Congress had been made aware of the serious noncompliance of businesses and self-employed individuals who failed to report all of their income from business sources.  Laws requiring reporting of payments made by those in the conduct of a trade or business were added.  Civil penalties for noncompliance were enacted.  Backup withholding taxes were enacted as a way to collect tax revenue from unreported business income.