Tis the Season for 1099’s . . . and Matching
In just a few short weeks, taxpayers around the country will begin to receive a myriad of different forms in the mail that report important tax information to be used in the preparation of 2014 tax returns. This will include Forms in the 1099 series, which report things such as interest, dividends, credit card receipts, and other miscellaneous income. These forms have long played an important role in the IRS’s ability to assure compliance for individual returns and are growing in their importance to taxing authorities as they work to assure compliance on business returns.
The IRS uses these 1099s, also called information reporting forms, to match what taxpayers report on their income tax returns to what the IRS has on file. For example, a bank is required to submit to its customers and the IRS a Form 1099-INT that reports the amount of interest the bank paid to the customers during the year. When taxpayers submit their tax returns, the IRS checks to make sure that the interest the bank told them about is reported on the returns. If not, the IRS generates and sends a notice instructing the taxpayers to take corrective action or explain the variance.
While this matching practice has been largely successful for individual returns, historically the IRS has had difficulty coming up with a system to ensure compliance for business returns. Of course, for businesses, income may be generated in multiple ways and many of those ways require no reporting. For example, there is no obligation for a customer to report to the IRS that they spent money at a restaurant. Compare this to the requirement that banks have to report amounts that they paid to an individual.
This all changed in 2012, however, when the IRS rolled out Form 1099-K, Payment Card and Third Party Network Transactions. Credit card companies, among others, are required to report to the government and the payee the amount of credit card receipts they generated using Form 1099-K. With this information, it’s easy to see how the IRS can then begin looking at a business’s reported gross receipts and flag discrepancies. Although credit card sales only tell part of the story for a business’s gross receipts, the IRS has developed software that attributes certain credit card to gross receipt ratios for certain business types and when the reported credit card transactions to gross receipts ratio deviates substantially from what the IRS expects, the IRS flags the return. Also, as explained below, the IRS is not the only party doing this type of matching; states are getting in on the action as well.
Combined Federal/State Filing (CF/SF) Program
The Combined Federal/State Filing (CF/SF) Program is an IRS-run program that forwards all electronically filed information returns to participating states. Participating states include Maine and Massachusetts. What this means for taxpayers is that participating states automatically receive all 1099s that are filed with the IRS, including 1099-Ks. Armed with the 1099-K’s, states are able to look at not only income tax returns, but other types of returns, for accuracy. One example is sales tax returns. In today’s day and age, with customers increasingly turning to credit cards as their preferred method of payment, states are recognizing this and giving those businesses that are required to charge sales tax on a great majority of their products a hard look. Similar to the IRS, when reported sales grossly deviate from 1099-K sales, the states will flag the return and may send notices or even initiate an audit. For those businesses that collected sales tax but failed to fully remit or report it, significant penalties await.
What should you be doing?
Individuals should be sure to provide all 1099s they receive to their tax return preparers for their use in generating tax returns. The IRS will compare the income reported on the 1040s to their own copies of the Forms 1099, and will note any variances. Business owners should also provide copies of Forms 1099 to their tax preparers, and should verify that all income is properly reported on both income tax returns and sales tax returns. Any unexplained disparity could raise red flags and subject them to interest, penalties, or an audit.
If you have any questions or would like to discuss 1099 matching further, please contact Merrill Barter at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.