G&G Associates Tax & Financial Consulting
Tax Tip of the Week
How to keep your 1099 from starting an IRS audit
Imhotep (Wisdom to You) G&G Readers,
What Is 1099 Income and Why Does the Definition Cause an Incorrect 1099 and a Possible IRS Audit?
An incorrect 1099 that overstates your income is a problem that can lead to a tax audit. One big cause of an incorrect 1099 is the definition of what is 1099 income.
In many instances, the common fix to the incorrect 1099 is technically incorrect and that can cause distortions that lead to an IRS audit.
In this article, you will learn how the technically correct method does the following:
1. reduces your chances of an IRS audit,
2. grants the recipient their correct 1099 income, and
3. allows the payor the correct deduction.
Tax Question: I am a self-employed engineer. Last year I received three payments of $49,000 and one 1099-MISC for three jobs that I completed and billed to one customer. The customer paid the last invoice at the very end of December and I did not receive the check until 2011.
I know that technically I can claim $98,000 as income; after all, that’s what I received as 1099 income in calendar year 2010. However, I think the IRS will not like the incorrect 1099-MISC for $147,000 when I report gross income of only $98,000 on Schedule C of my Form 1040.
Thus, my question: How do I report $98,000 as income and avoid an IRS audit?
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I’m going to give you the technically correct answer because that answer is technically correct and it will reduce your chances of an IRS audit.
THE AUDIT …
You might ask: How will the technically correct answer reduce my chances of an IRS audit? Answer:
1. You will report $98,000 rather than $147,000 on your Schedule C. The IRS selects more $147,000 Schedule C tax returns for audit than $98,000 Schedule C’s.*
2. You will have a corrected 1099 that matches your $98,000 reported income. Because you have a corrected 1099, you don’t have that $49,000 sore getting attention from the IRS computers.
OVERVIEW OF TECHNICALLY CORRECT REPORTING
Here is an overview of how the rules on a 1099 work. Following this overview, I will dive deeper into the rules and give you insight into how to go about this.
1. The Form 1099 that you received is technically incorrect because the payor is supposed to report on the 1099 payments that you received during the year. Note that this is not the amount paid to you during the year, but rather the amount received by you during the year.
2. You should contact the payor to get a corrected 1099-MISC. You likely will want to send the payor the IRS regulation that explains why your 1099 is incorrect.
3. If you cannot get the 1099-MISC corrected in time for filing your tax return, do this: Report the correct amount ($98,000) on Line 1 of Schedule C and attach an explanation.
4. Keep the envelope in which the final payment arrived as proof that the money arrived after December 31st.
Why the Payor Gave You an Incorrect 1099-MISC
IRS Reg. Section 1.6041-1(f) says:**
The amount to be reported as paid to a payee is the amount includible in the gross income of the payee …
Note … As you will see below, this amount does not necessarily equal the tax deduction claimed by the payor.
IRS Reg. Section 1.6041-1(h) says:***
For purposes of a return of information, an amount is deemed to have been paid when it is credited or set apart to a person without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and is made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition.
Note that the regulation above is for a “return of information,” one such return of information is the 1099-MISC.
IRS CASE LAW
In Cheryl Mayfield Therapy Center, the court stated:^
A “payment” is made for purposes of section 6041 information returns when an amount is made available to a person “so that it may be drawn at any time, and its receipt brought within his own control and disposition.”
As I was doing the research for this article, I was a little surprised that the 1099 could contain a taxable amount to the payee that is different from the deduction amount of the payor.
For example, in your case, the correct 1099-MISC amount is $98,000. That’s the amount the payor should put on your 1099-MISC even though the payor is going to deduct $147,000.
Let’s say you did no work for this payor in the year following the year when your 1099-MISC reported $98,000. In this next year, the payor will send you a 1099-MISC for $49,000, but the payor will deduct nothing for the next year’s 1099-MISC.
IF THE 1099-MISC Is NOT CORRECTED
Depending on what the incorrect 1099-MISC is doing to your income, you have one of two ways to show or not show the correction.
If the income on your tax return will be less than the total of your 1099-MISCs, you can bet that the IRS computers will pick that up. Therefore, follow the instructions below, which appear on the back of the 1099-MISC:^^
Form 1099-MISC incorrect:
If this form is incorrect or has been issued in error, contact the payor. If you cannot get this form corrected, attach an explanation to your tax return and report your income correctly.
Some practitioners like to report the incorrect 1099 amount in the income line so that it matches with IRS records. Then, they enter an offsetting expense to make the income right. Finally, they add a statement to the return explaining the fake expense number and why it is there.
If the income on the tax return is greater than the total of the 1099-MISCs, follow the instructions for Line 1 of Schedule C, which state:^^^
Enter gross receipts from your trade or business. Include amounts you received in your trade or business that were properly shown on Forms 1099-MISC. If the total amounts that were reported in box 7 of Forms 1099-MISC are more than the total you are reporting on line 1, attach a statement explaining the difference.
Important. These instructions say to attach a statement when the forms 1099-MISC are more than the total income you are reporting. When the forms 1099-MISC are less than the reported income, no explanations are necessary because your total income is correct.
Here’s a final thought: You probably should retain proof that you tried to get the 1099-MISC corrected. Adequate proof might include a fax copy and a fax receipt showing delivery of the request, a copy of a letter you sent by certified mail along with the certified mail receipts, or an email with acknowledgement of delivery.
* Interestingly, IRS audits of Schedule C taxpayers with total gross receipts over $200,000 are less than audits of Schedule C taxpayers with total gross receipts of $100,000 and under $200,000.
** Reg. Section 1.6041-1(f)
*** Reg. Section 1.6041-1(h)
^ Cheryl Mayfield Therapy Center v Commr., TC Memo 2010-239
^^ IRS Form 1099-MISC (2011); see www.irs.gov
^^^ 2010 Instructions for Schedule C
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Ankh Uja Snb (Life, Strength, & Health),
Asar Gary Gray
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