IRS: “You Know That New K-2/K-3 Requirement: Well, We Had Second Thoughts.”

February 16th, 2022

UPDATE: Make sure you read the post of February 17, 2022 on this issue.

Every so often the IRS actually listens to the tax professional community.  Tax professionals were unanimous in stating that requiring a domestic partnership with no foreign partners and no foreign operations to complete the new Schedules K-2 and K-3 was stupid; it’s similarly stupid for an S-Corp with no foreign operations.  (I wrote about this requirement 11 days ago.)  The IRS added the following notice to a special page on the 2022 Tax Season:

Coming relief from certain Schedule K-2 and K-3 reporting: The IRS intends to provide certain additional transition relief for this year from the Schedule K-2 and K-3 reporting for certain domestic partnerships and S corporations with no foreign activities, foreign partners or shareholders, and without knowledge of partner or shareholder need for information on items of international relevance. For 2021, these qualifying domestic partnerships and S corporations will not have to file the new schedules. We are taking this step in response to feedback we received from the tax community and our stakeholders. The IRS will provide full details of this relief soon.

It;s great that the IRS realized the problems that these new schedules involve for tax professionals and taxpayers during what is sure to be a challenging Tax Season.  However, there’s still a long-term problem that needs to be resolved.

Consider Harry, a partner in a domestic partnership (call it Acme) with no foreign partners and no foreign operations.  He and his wife typically have about $400 of foreign tax paid through a different partnership he’s a partner in.  He tells the managing member of Acme that for 2022 (next year’s taxes filed in 2023) he doesn’t have a Form 1116 filing requirement.  Acme timely files its 2022 return and doesn’t include Schedules K-2 and K-3.  In September, Harry receives the other partnership’s K-1, K-2, and K-3 and discovers that this year there was $610 of foreign tax paid.  Does Acme now have to amend its 2022 returns?  Is Acme subject to draconian penalties even though the partner had no way of knowing about the Form 1116 requirement? 

There are three courses of action the IRS should choose among for the long-term resolution of the issue.  They could just use a de minimis threshold of somewhere between $1 million and $25 million of sales; entities with sales below that and no foreign partners and foreign operations would be exempt.  The IRS could base whether Schedules K-2 and K-3 need to be filed on the prior year’s requirements for filing Form 1116.  Or the IRS could just drop the requirement to file these forms for domestic entities with no foreign partners or operations.

Unfortunately, I suspect all that’s happened is the problem has been postponed one year.

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That 6 Million Return Backlog? Oops, We Mad a Math Error: It’s Really 24 Million

February 12th, 2022

Everyone makes math mistakes.  When we last heard from IRS Commissioner Chuck Rettig, the backlog of unprocessed returns was down to about 6 million.  Per the Washington Post, that was slightly off–well, a bit more than slightly.  The true backlog is 23.8 Million,  a difference of about 18 million returns.  True, this does include unopened correspondence–but that correspondence also likely includes returns.

Of course, you can try calling the IRS up.  I generally do multiple times during a week.  I have about twelve items I need to get resolved and (in theory) I can over the phone, (a) if I get through, (b) I speak to an IRS employee who can resolve the issue, and (c) don’t get hung up on.  Here’s an example: A client paid his tax in October, the IRS cashed the check, but the payment isn’t posted on his account.  He just received a CP504 notice, gave me a Power of Attorney, and sent me a copy of the front and back of the check (and it absolutely cleared).

The first issue is calling the IRS.  I’m in the Pacific time zone, so when I call at 7am (the earliest time I can call), I’m competing against everyone else in the US.  On Monday I couldn’t get through to the Practitioner Priority Service (PPS).  I made ten attempts, and then stopped as I had a full day of appointments.  On Tuesday, I reached the IRS–and was not even on hold!  That’s akin to a one-outer in poker.  The helpful IRS employee (and do note that every IRS employee I’ve dealt with on PPS has been very helpful) could not help me; she did not have access to the computer system that allowed transferring of payments.  She transferred me…and I was on hold with a hold time given of “between 30 and 60 minutes.”  90 minutes later, the IRS system hung up on me (I think it may be programmed to do that when you’re on a call and it lasts two hours).  I couldn’t try to call again on Tuesday, because I had appointments.

On Wednesday, my fourth try to PPS resulted in a callback from the IRS 30 minutes later.  This employee found my client’s payment, and then started the work to move the payment–which apparently was a lot more complex than either he or I thought it would be.  Every five to seven minutes he’d get back on the line stating he was still working on this form to move the payment.  After 100 minutes, the system hung up on me.  On his last “I need another five to seven minutes” he said he was close to having this resolved.  But I don’t know for sure.

On Thursday I had an outside appointment, and by the time I got into the office I didn’t have an open two hours to call the IRS.  (I can work while I’m on the phone with the IRS, but I can’t have a scheduled call or appointment.)  On Friday, I didn’t get through to the IRS.  On Monday, my first scheduled call is at 11am, so I am hopeful I can confirm that this payment has been resolved, and then go on to issue number two (a 2016 return that still hasn’t been processed).

Last week, 30 Senate Republicans wrote a letter to Treasury Secretary Janet Yellen and Commissioner Rettig that the situation is untenable.  They’re correct.  So what can we do–given that it’s likely impossible to salvage the 2022 Tax Filing Season from being on the level of disastrous?  I have some ideas:

  1. Drop the Schedule K-2 and K-3 requirements for all but the largest partnership and S-Corporations (say, $25 million in gross income or more) for 2021 returns.  This will (a) eliminate even more paperwork for the IRS to process (currently, K-2s and K-3s must be attached as pdf’s to returns; this requires the IRS to do special processing), (b) help the tax professional community, and (c) help most taxpayers where these documents add just filing requirements with no tangible benefits to anyone.
  2. Get all IRS employees who are supposed to work in IRS Service Centers back in the Service Centers.  Yes, Covid still exists but it’s going to be with us (likely) forever.  This can be done by Presidential executive order–and Treasury Secretary Yellen and IRS Commissioner Rettig should be demanding this.  This will eliminate the issue with “error” returns (see below).  Additionally, it will increase IRS efficiency: employees will be in the locations they should be in.
  3. Start posting realistic time-frames for processing of paper returns.  I’m quoting 12 months for a paper-filed tax return and 18 months for a paper-filed amended return.  For electronically filed tax returns, I’m quoting two to four weeks if you’re in the lucky 90% that don’t get an error/reject and nine months if you’re in the unlucky 10% that does get an error/reject.  For electronically filed amended returns, I’m quoting one year for processing.  (All time-frames are averages.)  If my suggestion about getting employees back in the Service Centers is acted on, that will reduce the backlog of returns as error/reject returns won’t take the months that they currently take to be resolved (pre-Covid, they took three to four days).
  4. Listen to TIGTA (the Treasury Inspector General for Tax Administration) and spend what technology money you have wisely.  Yesterday, TIGTA released a report noting that the IRS cost the US $56 million in interest payments because of outdated mail processing equipment that would cost between $360,000 to $650,000 to replace.
  5. Work with Congressional leadership to get the budget increased for improved technology, not snooping on bank records.  Secretary Yellen and Commissioner Rettig can point out that improved technology would allow for far greater efficiency within the IRS.  Do you know that the main IRS computer system dates from 1959 and uses COBOL, and the last major improvements date from the 1980s?  Given the current situation, there should be bipartisan support for this.  Yes, this wouldn’t have benefits for a few years but we have to start somewhere.
  6. Work with Congressional leadership to increase starting wages for IRS employees.  The IRS is trying to hire more individuals (including in customer service), but has only hired 10% of the number they want to hire (and are budgeted to hire).

By the way, do you know how many IRS employees there are per phone call coming in to the IRS?  For every 16,000 calls, there’s one employee.  (Yes, employees take more than one call a day, but if you wonder why you and I can’t get through, that’s the answer.)

What does this mean for the 2022 Tax Season?  If your tax professional doesn’t have gray hair, he or she will by October 15th.  If you need to call the IRS, budget a day to get through (you will likely need it).  If you have to write the IRS (or submit a paper return) and need a quick response, consider a prayer: It can’t hurt and it just might help.  And hug your tax professional; he or she will appreciate it.

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On NFTs, DeFi, DAOs, and Staking: Cryptocurrency Taxation (2022) (Part 1)

February 6th, 2022

With NFTs (non-fungible tokens), DeFi (decentralized finance), DAOs (decentralized autonomous organizations), and staking the rage in cryptocurrency, there are a lot of questions on what this means for taxes.  Then on Friday I see headlines like, “IRS Will Not Tax Unsold Staked Crypto As Income.”  So before I move toward NFTs et. al., let’s start with this report and staking.  And even that has issues as there are many different kinds of staking.

Here, the staking involved is for Tezos.  The taxpayers  received about $9,400 of Tezos and they had to decide how it should be taxed.  The problem is that while the IRS has ruled cryptocurrency is property, and how airdrops and similar things are taxed, the IRS has not given definitive guidance on staking.  Should you use the principle that since you received $9,400 of value, you have $9,400 of income?  (In that scenario, when you sell it you will have a capital gain or loss with $9,400 of basis.)  Or should it be no income today but income tomorrow when you sell the Tezos?  (Here, you would have ordinary income of whatever you sell the Tezos for.)

The major issue in determining what to do is that it has typically taken the IRS three years to issue rulings on cryptocurrency matters.  When there is no law, regulation, or guidance, taxpayers are required to use general tax law principles. Given how the IRS has ruled on airdrops, it’s more likely than not the IRS will rule that the Tezos the taxpayer received were income when received.

Indeed, that’s what the taxpayers did on their originally filed tax return for the 2019 tax year.  The taxpayers then filed an amended return asking for a refund (based on that $9,400 not being income).  That they didn’t receive a response isn’t a surprise: It’s taking the IRS twelve months to process an electronically filed amended return; it’s taking 18 months for paper-filed amended returns.  Under the law, if you file a “Claim for Refund” (which is done by filing an amended return asking for a refund) and the IRS doesn’t respond within six months, you can file a court action in federal District Court or the federal Court of Claims.  The taxpayers filed a court case demanding the refund in District Court.

Last week, the federal government offered to give the refund.  This led to those headlines stating unsold staked crypto is not income.  Unfortunately, those headlines are anything but true today.  (It is possible they may be true tomorrow, though.)  The action by the Department of Justice could be for any number of reasons:

  • The IRS doesn’t like the fact pattern of this case, and would prefer to fight a different case;
  • The IRS wants to delay this issue until they have more time to study it; or
  • The Department of Justice looked at the cost of fighting this case and the dollar amount of the refund, and decided it made economic sense to let the taxpayers have the refund.

Had the taxpayers accepted the refund (they did not), this would not have led to a precedential ruling that unsold staked crypto is not income.  It would have been solely related to those taxpayers and that fact pattern (the Tezos they received).  Had the taxpayers received some other crytpo via staking in 2020, they would have had to fight the IRS again.  It definitely would not have been applicable to any other taxpayers.

As I noted, the taxpayers did not accept the US government offer, so the case moves forward.  As of today, there is no trial date scheduled.  It is possible that the judge will rule in favor of the US government or the taxpayers.  Given that there is no trial date, it’s possible there will not be a ruling in this case until 2023.  If the government wins, I would expect the taxpayers to appeal (to the Sixth Circuit Court of Appeals because the taxpayers reside in Tennessee); they have stated they would like to have a precedent set.  If the taxpayers win, the US could just pay the refund amount or appeal.  If they pay, that would lead to a nonprecedential case.  It would be binding on the taxpayers and the IRS as to the fact pattern in the case, but it would not be binding on you or I.  If the US appeals, it might or might not lead to a precedential decision; not all appellate ruling are considered precedential.  Even if there is a precedential ruling, it would only be binding in Kentucky, Michigan, Ohio, and Tennessee (though other courts would likely look at the decision).

What does this mean for today?  First, the headlines that unsold staked crypto isn’t income are not true.  Everyone is still required to use basic tax principles in determining whether this kind of staking leads to immediate income (or not).  In a later part of this series I’ll look a little more in depth at staking and explain why a taxpayer win in this case might not be a win (and could be a loss for taxpayers).  We also have to consider how the doctrine of constructive receipt fits into staking.  Second, the most conservative course of action is to include staking as income (when received).  I believe it is more likely than not that’s how the court will rule.  (The taxpayers do have some tax law on their side, though; this is definitely not a slam dunk case.)  Third, until the court actually rules nothing has changed.  The IRS offer to pay the refund could have nothing to do with the case itself.  The best analysis of this case that I’ve seen is from the National Law Review; I would strongly advise anyone involved with cryptocurrency staking to peruse the linked article for a far better analysis of the matter than almost anything else I’ve seen.  Finally, anyone involved in such staking should discuss this with their tax professional.  There are some options as it relates to the 2018 tax year that fall off a cliff in April that taxpayers may want to consider.  Additionally, there are options in how this activity is treated on your tax return that you and your tax professional should discuss.

(The court case is Jarrett v. United States, No. 3:21-cv-00419 (M.D. Tenn.).)

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The K-2/K-3 Kerfuffle

February 5th, 2022

The IRS announced a year ago that there would be two new forms for partnerships and S-Corporations with international income and/or partners: Schedules K-2 and K-3 (links are to the partnership versions of these forms).  Most tax professionals would have a return or two that had to deal with these new schedules; no one believed it would be a big deal.  Indeed, the original IRS instructions for these forms confirmed that.

And then the IRS changed the instructions.  Most of these changes are technical and of little concern to the public.  However, the IRS made a major change related to the interaction of these schedules and Form 1116 and Form 1118 (Foreign Tax Credit).  The change–which I’ll detail below–means that almost every partnership (and many S-Corporations) will need to complete at least a portion of these new schedules.

The IRS added an example in the new instructions of when a partnership does not need to complete Schedules K-2 and K-3:

Example. U.S. citizen A and U.S. citizen B own equal interests in domestic partnership. In Year 1, domestic partnership has no foreign source income and no assets that generate foreign source income. Domestic partnership does not pay or accrue foreign taxes. In Year 1, U.S. citizen A pays $100 of foreign income taxes on passive category income which was reported to U.S. citizen A on a qualified payee statement. U.S. citizen A does not pay or accrue any other foreign taxes and has no other foreign source income. U.S. citizen B does not pay or accrue foreign income taxes. In Year 1, because U.S. citizen B paid no foreign taxes for which it can claim a foreign tax credit and U.S. citizen A qualifies for the exemption from completing Form 1116 to claim a foreign tax credit and such information was provided to domestic partnership by both U.S. citizen A and U.S. citizen B, domestic partnership need not complete Schedules K-2 and K-3, Part I, box 1, box 2, box 3, box 4, box 5, and box 10, Parts II or III.

In English, this means that if a tax professional is certain that no partner is taking a foreign tax credit where Form 1116 or Form 1118 is completed, then Schedules K-2 and K-3 do not need to be completed.  The problem is that in almost all cases, tax professionals will not know this and will have no way of knowing this!

Form 1116 is exempt on a personal return if you have $300 or less in foreign taxes paid ($600 if married filing jointly).  Consider Acme Partners–with Bill, Jane, and Ralph as partners.  It has no foreign activities at all, so you would think it would be exempt from Schedules K-2 and K-3.  Bill and Jane have no foreign income of any sort.  Ralph, though, invests in lots of partnerships that issue him K-1s.  Some years he’s had $1,000 of foreign tax paid; other years, it’s $10.  Ralph isn’t on good terms with Bill and Jane, but Ralph is still a partner.  Russ is the tax professional, and he deals with Bill in getting the return prepared.  Russ can ask Bill, “Will any of the partners file Form 1116?”  We have a number of issues:

  1. Whether Form 1116 is required might not be known until each partner receives all of his or her K-1s (and that can be in mid-September).  There’s an obvious circular issue here: Whether a partner needs to file Form 1116 depends on all the K-1s (and K-2/K-3s), but you’re preparing a K-1 (and K-2/K-3).
  2. What if a partner refuses to discuss this with the “Tax Matters Partner?”  Conflict of interest rules under Circular 230 (the regulations governing tax professionals) likely prohibit the tax professional from asking the recalcitrant partner.
  3. What if one or more partners honestly doesn’t know?
  4. Why should a partnership with only US activities complete Schedules K-2 and K-3 given that (a) there is no international activity; (b) there are no foreign partners; and (c) the IRS can accurately determine the income and expenses of the partnership (and accurately determine each partner’s share of income) from the return and the Schedule K-1.  Additionally, any partner who is filing Form 1116 can accurately complete it using Schedule K-1 for a US-only partnership.
  5. Completing Schedules K-2 and K-3 will add time and cost to any partnership return.
  6. As of today, the IRS estimates it will be ready to accept efiled Schedules K-2 and K-3 for partnerships on March 17th (partnership returns are due on March 15th).  It’s even worse for S-Corporations: the IRS is estimating it will be ready for those Schedules K-2 and K-3 in the May to June time-frame (S-Corporation returns are due on March 15th, too).
  7. The IRS is allowing “transition relief” for 2021 returns, but a “good faith” effort is supposed to be made to prepare the new schedules.

There are only three solutions that I can see.  The first–and best–is that the IRS simply state that a partnerships and S-Corporations with no foreign activity or partners need not file Schedules K-2 and K-3.  The reality is that the IRS does not need such partnerships (and S-Corporations) to complete the forms in order to determine whether a partner’s (or S-Corporation shareholder’s) Form 1116 (or Form 1118) was completed accurately.  The second possible solution is for the IRS to allow a statement to be attached to the return stating that the partnership has no foreign income (similar to the de minimis property regulation statement).  The third solution is just to postpone Schedules K-2 and K-3 until the 2022 tax year so that a workable solution can be found.

If the IRS continues down their current path, I do not see a way around preparing Schedules K-2 and K-3 for almost every partnership.  For perhaps 10% of the partnership returns we prepare, we also prepare all partners’ tax returns (most of those are husband-wife partnerships); for those, we can determine if we must prepare Schedules K-2 and K-3.  For the other 90%, I will have no choice but to prepare these schedules.  This will add at least 20 minutes of work for each return (possibly more), and that will add to every client’s bill.  Additionally, all of these partnerships will have to go on extension.  And by the time March 17th comes and I can efile the returns, we’ll be buried in personal returns.

The issue is less of one for S-Corporations.  Perhaps half of the S-Corporation returns we prepare are one-owner returns.  For those, we know whether they need to include Schedules K-2 and K-3.  Still, we will have many impacted returns; all of those returns will need to be extended (and the owners’ personal returns will all have to be extended).

This was already shaping up to be a miserable Tax Season. This change is only going to make miserable year turn nightmarish.  If anyone from the IRS reads this, please reconsider what you’ve done or postpone it a year.

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“Amount Due by January 3, 2022….”

February 4th, 2022

We receive lots of IRS notices for clients.  In yesterday’s mail, we received two CP14 notices.  These state that a taxpayer filed a return with a balance due.  Many times this is an issue of the return being processed before the payment; sometimes, of course, the taxpayer truly owes the tax.

In this case, there’s a deeper issue.  Both notices were dated December 13, 2021 with payments due on January 3, 2022—more than a month ago.  This is clearly an IRS issue (not a Post Office issue, as we received two such notices sent from two different IRS Service Centers).  There was no insert giving the taxpayer more time to pay.  It appears the IRS again has a backlog of notices to be mailed, and is sending out notices late.

One of the two taxpayers received a CP503 notice in January (noting the balance due, but with no explanation of the amount); for the other taxpayer, this is the first communication from the IRS that has been received.  The taxpayer who received the CP503 notice has paid his tax (and the account has a $0 balance), but assume for the moment you received such a notice.  Wouldn’t you call the IRS up and ask them did you get my payment?

The IRS sending notices late will only add to the phone volume, making it even harder to reach the IRS for callers who truly have issues.  I’m not sure why these notices were sent seven weeks after the date on the notices, but this is just adding to a miserable Tax Season.

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Hug Your Tax Professional: The IRS Is At It Again

January 20th, 2022

I was hoping that the 2022 Tax Season (which begins for individuals on Monday) would be more pleasant than the last two.  Yes, the IRS didn’t cause Covid; however, as the National Taxpayer Advocate noted in her recent report the IRS’s response has been (to put it charitably) ‘lacking.’  It doesn’t look like things are improving based on three items in the mail.

The first is the most serious.  The IRS is sending out letters (Letter 6419) noting how much taxpayers received in the Advance Child Tax Credit (ACTC).  Yesterday, a client received hers.  The letter noted that she had received $1,000.  She went through her records and found that was wrong (she received a little over $800).  The letter gives a phone number to call if there’s a discrepancy–which she did.  The helpful IRS agent told her that the letter is wrong, and that the information my client had (which she got from her bank records) was accurate.  “The IRS is aware of the issue.”

Are corrected letters going to be sent?  Is this a widespread issue or is it just (say) less than 1% of all letters?  What will happen when I file the client’s return noting the correct amount of ACTC?  Will the IRS use the letter’s $1,000 or the correct amount in verifying the return?  Will a whole bunch of returns have very slow processing because of this?  (Undoubtedly, yes.)

I just saw on Twitter other tax professionals seeing the same issue, so it’s clear there’s a problem.  Hopefully, it’s just a few individuals…but I have my doubts.

The second issue relates to an IRS notice that come on Tuesday, January 18th.  The notice is dated December 6, 2021 and asks for payment by December 27, 2021.  Given how bad the mail has been it’s possible this is a Post Office issue rather than IRS, but I strongly suspect the IRS is again sending out notices well after their dates.  There was no insert telling me that the client has longer to pay.  Again, is this a one-off or the start of a trend?

The third issue involves a correspondence examination.  A client was selected for a correspondence exam.  We needed additional time to get the paperwork together; the IRS gave us an additional month (to January 5th).  We sent our response to the IRS on January 3rd.  In yesterday’s mail, the IRS has now assessed the tax with an audit report dated December 27, 2021.  Yes, the IRS ignored the extension it gave.  Yes, I will have to call the IRS to see what’s going on and why the IRS’s left and right hands have no idea what they’re doing.  Yes, this adds to the call volume at the IRS–and it shouldn’t have happened.

This is not a good start to the 2022 Tax Season.

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Frozen Returns: If You Made an Extension Payment on May 17th And Haven’t Received Your Refund….

January 11th, 2022

Yesterday, a client of mine called asking about her 2020 tax refund.  I assumed she was one of the unlucky individuals whose return fell out of IRS processing and is stuck waiting to be reviewed.  However, she told me that her return didn’t even show in the IRS’s “Where’s My Refund.”   I confirmed that–and that didn’t make any sense; her return was filed on September 30th and accepted that day.

I called the IRS and discovered another reason some haven’t received their refunds.  If you made an extension payment on exactly May 17, 2021 (the last day to file a 2020 extension) and are receiving a refund, your return may have been “frozen” by the IRS computer system.  (I had my second such case today.)  I don’t know how extensive this issue is, but the representative I spoke to yesterday told me that he had dealt with “many” such cases.

Hopefully, someone at the IRS is going through frozen returns to manually unfreeze the returns without taxpayers having to call the IRS.  But if you made an extension payment on May 17, 2021 and have filed your return and have not received your refund, check IRS’s “Where’s My Refund.”  If no status at all is shown (the return does not show as still being processed), you or your representative needs to call the IRS and have the return “unfrozen.”

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Tax Season (For Individuals) to Begin on January 24th

January 10th, 2022

The IRS announced today that Tax Season will begin on Monday, January 24th.  That’s the first date that electronically filed returns (and extensions) for the 2021 tax year will be accepted for individuals.  (Businesses can already file their 2021 returns.)

Do note that almost every tax professional uses software, and that some forms may not be ready until after that date.  Additionally, some state forms and state returns will not be able to be processed until after January 24th.

You should not file your return until you have all your tax paperwork.  The deadline for brokerage firms to send their 1099s is February 15th (and it is routinely extended).  If you are a partner in a partnership, a shareholder in an S-Corporation, or a beneficiary of a trust, you must wait until you receive your K-1’s.  Remember, it’s better to extend than amend.

Finally, we do not expect the deadline for individual returns to be extended from April 18th.  That means you will need to file (or file an extension) by then.

As for how this year’s Tax Season will go, expect a repeat of last year.  The IRS still has not processed all 2020 returns (but they’re through April!).  Until IRS staff is fully back at their Service Centers, there’s no reason to expect anything to change.  This is not a scenario to make any IRS stakeholder–be it a tax professional, taxpayer, or Congressman–happy.  I can state for the record that I absolutely expect the same issues with delayed processing of refunds this year.  (I have a client whose 2019 return is still stuck in limbo!)

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It’s Time to Generate 2021 1099s

January 4th, 2022

It’s time for businesses to send out their annual information returns. These are the Form 1099s that are sent to to vendors when required. Let’s look first at who does not have to receive 1099s:

  • Corporations (except attorneys)
  • Entities you purchased tangible goods from
  • Entities you purchased less than $600 from (except royalties; the limit there is $10)
  • Where you would normally have to send a 1099 but you made payment by a credit or debit card

Otherwise, you need to send a Form 1099 to the vendor. The best way to check whether or not you need to send a 1099 to a vendor is to know this before you pay a vendor’s invoice. I tell my clients that they should have each vendor complete a Form W-9 before they pay the vendor. You can then enter the vendor’s taxpayer identification number into your accounting software (along with whether or not the vendor is exempt from 1099 reporting) on an ongoing basis.

Form 1099-NECs have a filing deadline of January 31, 2022 (for reporting 2021 nonemployee compensation). Form 1099-MISCs are used for all other 1099 reporting except interest, dividends, capital gains, etc. Payments of rent, royalties, advertising, crop insurance proceeds, substitute payments in lieu of dividends, attorney proceeds, other income (including gambling winnings not reportable on a Form W-2G), and nonqualified deferred compensation are just some of the items reported on a Form 1099-MISC.

Remember that besides the 1099 sent to the vendor, a copy goes to the IRS. If you file by paper, you likely do not have to file Form 1099-MISC with your state tax agency (that’s definitely the case in California). However, if you file 1099s electronically with the IRS you most likely will also need to file them electronically with your state tax agency (again, that’s definitely the case in California). It’s a case where paper filing might be easier than electronic filing.

IMPORTANT: The IRS is not sending Form 1099-NECs to state tax agencies. Thus, if you have a state filing requirement for your Forms 1099-NEC, you must separately file this with your state tax agency.

If you wish to file paper 1099s, you must order the forms from the IRS. The forms cannot be downloaded off the Internet. Make sure you also order Form 1096 from the IRS. This is a cover page used when submitting information returns (such as 1099s) to the IRS.

Note also that sole proprietors fall under the same rules for sending out 1099s. Let’s say you’re a professional gambler, and you have a poker coach that you paid $650 to last year. You must send him or her a Form 1099-NEC. Poker players who “swap” shares or have backers also fall under the 1099 filing requirement (issuing form 1099-MISC).

Remember, the deadline for submitting 1099-NECs for “Nonemployee Compensation” (e.g. independent contractors) to the IRS is now at the end of January: Those 1099s must be filed by Monday, January 31st.

Here are the deadlines for 2021 information returns:

  • Monday, January 31st: Deadline for mailing most 1099s to recipients (postmark deadline);
  • Monday, January 31st: Deadline for submitting 1099-NECs for Nonemployee Compensation to IRS;
  • Monday, February 28th: Deadline for filing other paper 1099s with the IRS (postmark deadline);
  • Tuesday, March 15th: Deadline for mailing and filing Form 1042-S; and
  • Thursday, March 31st: Deadline for filing other 1099s electronically with the IRS.

Remember, if you are going to mail 1099s to the IRS send them certified mail, return receipt requested so that you have proof of the filing.

Also note that most 1099s must be mailed to recipients. Mail means the postal service, not email. The main exception to this is if the recipient has agreed in writing to receiving the 1099 electronically. I consider this the IRS’s means of trying to keep the Post Office in business.

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It’s Time to Start Your 2022 Mileage Log

January 3rd, 2022

I’m going to start the new year with a couple reposts of essential information. Yes, you do need to keep a mileage log:

Monday will be the first business day of the new year for many. You may have resolved to keep good records this year (at least, we hope you have). Start with keeping an accurate, contemporaneous written mileage log (or use a smart phone app–with periodic sending of the information to yourself to prove that the log is contemporaneous).

Why, you ask? Because if you want to deduct all of your business mileage, you must do this! IRS regulations and Tax Court rulings require this. Written is defined as ink, so that means you need a paper log or must be able to prove your smart phone log is contemporaneous.

The first step is to go out to your car, and note the starting mileage for the new year. So go out to your car, and jot down that number (mine was 117,392). That should be the first entry in your mileage log. I use a small memo book for my mileage log; it conveniently fits in the center console of my car. It’s also a good idea to take a picture of the odometer and email that picture to yourself. This will give you a time-stamp showing you accurately noted your beginning mileage.

Here’s the other things you should do:

On the cover of your log, write “2022 Mileage Log for [Your Name].”

Each time you drive for business, note the date, the starting and ending mileage, where you went, and the business purpose. Let’s say you drive to meet a new client, and meet him at his business. The entry might look like:

1/4 117400-117435 Office-Acme Products (1234 Main St, Las Vegas)-Office, Discuss requirements for preparing tax return, year-end journal entries.

It takes just a few seconds to do this after each trip, and with the standard mileage rate being $0.56/mile, the 35 miles in this hypothetical trip would be worth a deduction of $20. That deduction does add up.

Some gotchas and questions:
1. Why not use a smartphone app? Actually, you can but the current regulations require you to also keep a written mileage log. You can transfer your computer app nightly to paper, and that way you can have the best of both worlds. Unfortunately, current regulations do not guarantee that a phone app will be accepted by the IRS in an audit.

That said, if you backup (or transfer) your phone app on a regular basis, and can then print out those backups, that should work. The regular backups should have identical historical information; the information can then be printed and will function as a written mileage log. I do need to point out that the Tax Court has not specifically looked at mileage logs maintained on a phone. A written mileage log (pen and paper) will be accepted; a phone app with backups should be accepted.

2. I have a second car that I use just for my business. I don’t need a mileage log. Wrong. First, IRS regulations require documentation for your business miles; an auditor will not accept that 100% of the mileage is for business–you must prove it. Second, there will always be non-business miles. When you drive your car in for service, that’s not business miles; when you fill it up with gasoline, that’s not necessarily business miles. I’ve represented taxpayers in examinations without a written mileage log; trust me, it goes far, far easier when you have one.

3. Why do I need to record the starting miles for the year? There are two reasons. First, the IRS requires you to note the total miles driven for the year. The easiest way is to note the mileage at the beginning of the year. Second, if you want to deduct your mileage using actual expenses (rather than the standard mileage deduction), the calculation involves taking a ratio of business miles to actual miles.

4. Can I use actual expenses? Yes. You would need to record all of your expenses for your car: gas, oil, maintenance, repairs, insurance, registration, lease fees (or interest and depreciation), etc., and the deduction is figured by taking the sum of your expenses and multiplying by the percentage use of your car for business (business mileage to total mileage driven). Note that once you start using actual expenses for your car, you generally must continue with actual expenses for the life of the car. Be careful if you (or your family) have multiple vehicles. You will need to separate out your expenses by vehicle.

So start that mileage log today. And yes, your trip to the office supply store to buy a small memo pad is business miles that can be deducted.



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