What do you need to file your taxes?

I was asked to rush out 1099-MISCs to a client's independent contractors "so they could file their taxes," which got me thinking about what you actually need to file a tax return.

The most important thing is to know the types and amount of income and expenses you received last year. Information forms like W-2s, 1099s, etc. can be a tool for you, but I believe their primary purpose is to help the IRS identify unreported income.

Do you need a W-2?

I found several articles on the internet explaining how to file a tax return prior to receiving your W2. I don’t advise this, for a variety of reasons - one of which is that the W-2, when it arrives, doesn’t always match your last paystub, which can require you to file an amended return. If you file on paper, W-2’s and any other information forms that show withholding should be attached to your tax return.

Authorized IRS e-filers (like me), are prohibited from e-filing returns before all the W-2s, W-2Gs and 1099-Rs are received. (As you know, W-2s report wages and withholding, but unless you’ve been lucky, you may not have seen a W-2G which reports gambling winnings and any withholding, 1099-Rs report pension distributions, including early distributions from IRAs or 401(k)s). As I have received not only email alerts, but a paper mailing from the IRS just to remind me of this, I expect it to be an enforcement focus this tax season.

What if you don’t receive a W-2 (or other information forms)?

The first step is to contact the issuer (your employer for W-2s). The issue could be something as simple as you’ve moved and they don’t have your correct address. If you cannot contact the issuer, or you have and they will not supply the form, after February 14th, you can contact the IRS at 1-800-829-1040.

If there is no other resolution, you (or your tax preparer) can prepare a substitute form (form 4852) that contains not only the missing data from the original form, but a description of how you arrived at your figures, and what steps you’ve taken to obtain the missing document. You can use the same form if you believe the W2 you were issued was erroneous. Like your tax return, you are required to sign this form under penalties of perjury. The IRS states that returns with from 4852 are generally not filed before April 15th.

Other Independent Contractor Reporting Requirements

I mentioned in the 1099 posting that "if you are based in California and have a 1099-MISC reporting requirement, you were probably also required to submit a DE-542 within 20 days of paying over $600 or entering into a contract to pay over $600." Apparently that was a surprise to some, so I thought I’d talk a little more about new hire reporting as it affects independent contractors. If you are based in California, you may also want to see the information about California’s nonresident withholding requirements below.

History: Since 1997, the Personal Responsibility and Work Opportunity Reconciliation Act has required all employers covered under unemployment insurance law to report new hires to their state’s new hire registry within 20 days. While the goal of the requirement was to collect delinquent child support payments more effectively, states can also use the information to catch fraudulent unemployment, worker’s compensation and welfare claims. States have the option of imposing penalties up to $25 for failing to report new hires, and $500 if the failure is due to a conspiracy between the new hire and the reporting employer.

The above sets minimum requirements for the states new hire reporting. States can require that more reporting or impose shorter deadlines – you’ll notice on the chart that some states require reporting within as little as 7 days. Multistate employers can choose to report all of their new hires to one of the states in which they do business, but will be subject to that state’s reporting requirements – e.g. you probably wouldn’t choose Alabama with it's 7 day deadline :-).

Today: California isn’t the only state to require reporting of independent contractors as well as employees - you can see a list of states requiring independent contractor reporting here.

NOTE: Many folks have tried to save payroll taxes by treating their employees as independent contractors. Having the IRS or state employment agency decide after the fact that independent contractors were actually employees can be an expensive mistake, possibly costing not only back taxes, but penalties and interest as well as employee benefits like retirement or profit sharing.

The IRS looks at the degree of control and independence the contractor has – contrary to some of the bad advice my clients have received (before they were my clients), merely calling them contractors (or having them sign statements that they understand they are contractors) while treating them as employees won’t stand up under examination. Unfortunately, there is no single “bright line” test that separates contractors from employees. If you are not certain how to treat a service provider, you can use IRS form SS-8 to request a determination – be advised that it will take them about six months to get back to you. You may also want to check with your tax preparer, the IRS or your state employment department for more information (and your state may also offer advanced determination form - California has form DE-38).

California Offers Incentives to Encourage Nonresident Withholding

Since January 1, 2008 California payers are required to withhold 7% on payments of “non-wage” compensation to non-residents exceeding $1,500 per calendar year, and remit the amounts withheld quarterly.

Through March 15, 2009, California will consider waiving penalties for failure to file correct information returns if the delinquent returns are prepared and all interest is paid. Payers can remit past-due 2008 withholding as additional compensation to the nonresident. The Franchise Tax Board will also agree not to audit 2007 tax year and prior withholding to program participants.

What Types of Income are Subject to California Withholding?

Payments of over $1,500 annually for:

• Services provided in California by independent contractors
• Rents, Royalties
• Estate and Trust Distributions

Even though no withholding is required of California residents (including entities qualified with the CA Secretary of State to do business in California), payers of California source income should get a completed FTB form 590 “Withholding Exemption Certificate” from the payee.

7% Withholding is required for payments over $1,500 to nonresidents (including entities not qualified with the California Secretary of State to do business in California).

• Payees who are current on California taxes or meet other criteria can submit FTB form 588 “Nonresident Withholding Waiver Request” to request an exemption from withholding.


• Payees can also file FTB form 589 “Nonresident Reduced Withholding Request” to request reduced withholding based on their California income and expenses.

Forms 588 and 589 are due at least 10 days before payment is made.

Amounts withheld are due quarterly –generally on the 15th day of the month after the end of the quarter. More information is available at www.ftb.ca.gov/individuals/wsc/withholding.shtml

1099s - Due to Recipient February 2, 2009

Most of you who run small businesses know about 1099s. 1099s (specifically 1099-MISC) are issued for a variety of reasons, the best known being to report payments of over $600 to independent contractors for services, which is how I ended up spending a lot of time on the phone with the IRS -- the instructions are not clear for payments like software subscriptions that seem, to me, to fall somewhere between goods and services.

After repeated conversations with the IRS, it appears that whether or not software is customized for you determines whether it is a good or reportable service. (for example, Quickbooks is a good, a third party application that was written or modified *for you* to allow you to import transactions into Quickbooks is a service). In the same conversation, the IRS maintained that hosting and internet access are reportable services.

Here's more information on specific 1099-MISC reporting requirements. Need help? Mention this post to have up to 5 1099-MISCs prepared for only $25.

Disclaimer: These are the rules as I understand them. The IRS will probably agree, but since I don’t control them, I make no claim that they will in all cases.

You can view the IRS’s instructions at www.irs.gov/pub/irs-pdf/i1099msc.pdf. Please note that payments not reportable on form 1099-MISC may be reportable on other 1099 forms(for example, cancelled debt is reported on form 1099-C, or interest to investors reported on 1099-INT).

Also:

• Reporting is required only for payments made in the course of your trade or business (non-profit organizations a generally considered a business for this purpose).


• You generally don’t have to report payments to a corporation (unless they are business-related payments for medical or legal services, fish proceeds, or payments in lieu of dividends) or a tax-exempt organizations (including government entities).


• Payments for merchandise, telegrams, telephone, freight, storage and anything that meets the IRS’s definition of a “similar items” are also excluded.


• If you are based in California and have a 1099-MISC reporting requirement, you were probably also required to submit a DE-542 within 20 days of paying over $600 or entering into a contract to pay over $600. See http://www.edd.ca.gov/pdf_pub_ctr/de542.pdf