Imagine this…You file your tax return with deductions for fees paid to independent contractors you hired throughout the year. Two years later, the IRS is performing a random audit of your tax return and requests the 1099s filed related to these payments to support the deductions you claimed. They tell you that if you can’t produce the 1099s that were filed, the deductions taken for these expenses may no longer be valid which would create additional tax due, and a host of penalties. Panic mode sets in. This is potentially a huge deduction you could be missing out on. Can the IRS really do this?
Here’s where you can take a small sigh of relief. There is no provision in the tax law that denies you a deduction for labor expenses simply because you didn’t file the required Form 1099s. But the tax court has stated that the non-filing of required Form 1099s can cast doubt on the legitimacy of the deduction claimed.
As with any deduction claimed on the tax return, you have to keep sufficient records to prove the deduction amount. If you had filed Form 1099s, then this would have been solid documentation to help prove the expenses to the auditor. But since you didn’t file Form 1099s, you need to provide ironclad documentation to prove the expenses, including some or all of the following:
Bank statement transactions
Credit card statement transactions
Invoices from the contractor
Signed agreements with the contractor
A signed statement from the contractor verifying the amounts received
Signed W9s showing that the 1099 was not required to be filed due to the independent contractor’s entity type
Generally speaking, 1099s need to be filed by January 31st of the following year (for example, for expenses paid January 1 - December 31, 2023, the 1099-NEC must be filed by January 31, 2024 to be considered timely). If you fail to file the 1099 forms for independent contractors you paid who meet the 1099 filing criteria by the due date, you may be subject to a late filing penalty. The penalty applies if you fail to file timely, or did not include all the required information, or provided incorrect information. This penalty is also applicable if you were supposed to file electronically, but you filed on paper or reported incorrect Taxpayer Identification Number. The 1099 penalty increases with time. Here is how much the Federal penalties are currently:
$50 per 1099 if you correctly file within 30 days of the due date. The maximum penalty per year is $588,500 ($206,000 for small businesses).
$110 per 1099 if you correctly file more than 30 days after the due date but by August 1. The maximum penalty per year is $1,766,000 ($588,500 for small businesses).
$290 per 1099 if you file after August 1, or you do not file the required 1099. The maximum penalty per year is $3,532,500 ($1,177,500 for small businesses).
As you’ve gathered from this post, the easiest and most stress-free thing to do is collect W9s before paying an independent contractor, and timely file your Form 1099s to avoid any problems with the tax authorities. Need help with your Accounts Payable process, including collect Form W9s, evaluating the need to file Form 1099s, and actually filing the 1099 Forms? ASE Group can help! Schedule a consultation to talk to our team of experts today.