Inquiring Minds Want to Know

By: William J. Killory, CPA (Feb, 2012)

If we seem to be asking a lot more questions of you when we are preparing your returns it is not that we have become nosier, it's because the Internal Revenue Service has added more questions to your returns. Our tax system is a "voluntary" self reporting process that results in a flurry of activity every April 15th to meet that annual deadline. The IRS has a "trust but verify attitude" and has developed fairly sophisticated computer systems to match most sources of income to taxpayer identification numbers. The oft reported tax gap is the income that is not reported by third parties to the IRS that may be inadvertently omitted from returns. The IRS is making an effort to track down those missing numbers and has more ammunition to aid it in that quest.

The 2011 business tax returns for corporations, partnerships, self-employed and rental activity all have a line to report credit card receipts that are processed through your bank account. Third party processors like Visa and American Express are required to report to the IRS annual payments made to you through their system in excess of $20,000. This was part of the Health Care legislation that was passed in 2010 and many of you may be receiving a form 1099-K that has this information on it. The IRS initially wanted all businesses to report what they received on this separate line and somehow reconcile the numbers. For the 2012 filing season the IRS had previously indicated this separate reporting was not necessary and they announced in early February that they did not contemplate ever requiring a reconciliation of Form 1099-K to the tax return. In reviewing the enabling legislation it's not clear the IRS actually had the authority to do this anyway.

A two part question that is common to all business tax returns is did you make payments that would require you to file Form(s) 1099 and if yes did you or will you file all required returns? Before you decide to ignore the question you must remember that returns are filed under the penalty of perjury that the return, schedules and statements are true, correct and complete to the best of your knowledge. Failure to file these information returns can subject you to a penalty that starts at $30 per return if not filed by the end of February. This penalty can rise to $100 per return if filed after August 1 of each year. Intentional disregard of these rules increases the penalty to $250 per return. Failure to provide a correct return to the payee is subject to a $100 penalty.

Anyone who is engaged in the active conduct of a trade or business is subject to these rules. If you pay more than $600 to an unincorporated business (sole proprietorships, partnerships, LLC's) for services then you must obtain identifying information and issue a 1099-M to that business. The guy that takes care of your business's lawn and plows out the parking lot that you paid $1000 to last year is required to get a 1099-M. If he doesn't give you an EIN or Social Security number then you are required to withhold 20% of the amount paid as back-up withholding. If you pay this same guy $1,000 to plow your driveway at home, no 1099-M is required to be issued unless you are conducting business out of your house.

Payments to attorneys and health care practitioners all in excess of $600 even if they are incorporated are subject to the 1099-M reporting. Prizes and awards and rent paid in excess of $600 are also subject to this reporting requirement. Interest paid in excess of $10 requires a 1099-INT to be issued and payments of dividends out of earnings and profits of $10 or more will require a 1099-DIV.

There is a new question on Schedule B of your 1040 if you received over $1,500 in interest or dividends or have an interest in a foreign account or trust. The questions on Schedule B of Form 1040 ask first if you have any foreign accounts and then ask if you are required to file Form TD F90-22.1. If you have ownership or control of a foreign account in excess of $10,000 at any point in the year you must separately file Form TD F 90-22.1 commonly referred to as an FBAR report. Schedule B also asks if you have any foreign trust activity – either as a grantor, transferor or beneficiary of a distribution. If you answer yes to this question then you may need to add a Form 3520 to your return. Failure to file an FBAR or Form 3520 can result in a penalty that starts at $10,000 and goes up depending on the amount of affected accounts.

The IRS is serious about closing the tax gap. They are looking at the cash economy and trying to increase the required reporting via 1099's. They are also cognizant that this is fast becoming an international economy and it is much easier to set up accounts overseas where income is not reported to the IRS. You are required to report on all income from whatever source throughout the world whether you received a 1099 or not. To the extent that you paid tax in a foreign country on the foreign sourced income you generally will receive a credit on that income so you are not subject to double taxation. As your accountants we are not trying to be nosy but we really do need to know your business in order to assist you in filing that true, correct and complete return.

As always, please contact your Dermody, Burke & Brown tax advisor if you have any questions.

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