Form 1099 dilemma

[AccTaxMan]

Here is the story:

Client showed me a 2009 Form 1099-misc with nonemployee compensation reported on it (about $1,500). During the interview, I found this job is on-call basis and there is no regularity at all. He does it sporadically, maybe 2-3 times a year. He also has a regular W-2 job which is the majority of (95%) of his income.

According to IRS instruction, "An activity qualifies as a business if your primary purpose for engaging in the activity is for income or profit and you are involved in the activity with continuity and regularity. For example, a sporadic activity or a hobby does not qualify as a business".

Therefore, I came to the conclusion that it is not a business. So I reported the income on Form 1040 line 21 as other income. But since it is non-employee compensation, I reckoned he had to pay social security and medicare tax, otherwise he would receive a CP2000 in 2 years. So I have also prepared a Form SE in order to calculate and report the social security and medicare tax.

Now, my client is trying to do a refinancing and the lender is making a big issue out of the Form SE. They say the taxpayer is running a business if there is a Form SE in his tax return. My client denied. Therefore, they are going after me now. They want me to explain the Form SE. They even ask me to provide them a written explanation with my signature on it. I am being freaked out.

So did I handle the situation correctly? Would you handle the situation in the same way? Does the lender have the authority to require a written explanation with my signature on it?

I need help, guys.

[taxxcpa]

1099

All I would do is explain it to the bank. If they don't agree, just agree with them and say maybe you did it wrong, but if you had made a Schedule C the result would have been the same. You could even re-do it with a Schedule C to illustrate.

The only reason I would ever use line 21 would be if SE tax did not apply. You are probably right that line 21 is OK for his situation, but it would be just as easy to prepare a Schedule C-EZ to avoid any such hassles.

[FEDUKE404]

Not seen as an accountant issue

This sounds to me like a case of the tail wagging the dog.

I would have reported the income on a Sch C, or possibly Sch C-EZ, in the first place. There are those on these boards who have taken the "out" that it is not a regular business, therefore no Sch C. But that now seems to be a minority opinion.

Many folks are called upon to perform irregular consulting work, based on any number of reasons. (A friend is a photographer W2 employee, but during election years frequently performs some Sch C business.) Is such income somehow exempt from Sch SE taxes since it is not "regular"??

Personally I do not see you under any obligation to explain circumstances to the bank regarding underlying facts behind the tax return. You could even cite client confidentiality.

Many banks do require more information from a client whenever Sch C income is present, due to the overall unpredictability of such income. The only reason I could see to penalize the guy is some doubt as to what his regular total income is and/or is it sustainable. This would be a factor in his credit risk issues to the bank.

The client should be able to respond to such issues fully without any involvement on your part.

FE

[AJsTax]

This sounds to me like a case of the tail wagging the dog.

I would have reported the income on a Sch C, or possibly Sch C-EZ, in the first place. There are those on these boards who have taken the "out" that it is not a regular business, therefore no Sch C. But that now seems to be a minority opinion.

FE

If you want to call the IRS instructions a minority opininion, then maybe I might have to agree.
The question lies in whether the income came from a small business or sporadic, not to be repeated regularly, income. If it does NOT qualify as a business then it should be reported on line 21, without the SE. If it qualifies for SE it should have been on the Sch C.
So the taxpayer and tax preparer have to decide just how close to a small business this is and go from there.
I agree that the bank is not a tax expert and should not be able to question the preparer.

[taxxcpa]

Right way and wrong way

If you want to call the IRS instructions a minority opininion, then maybe I might have to agree.
The question lies in whether the income came from a small business or sporadic, not to be repeated regularly, income. If it does NOT qualify as a business then it should be reported on line 21, without the SE. If it qualifies for SE it should have been on the Sch C.
So the taxpayer and tax preparer have to decide just how close to a small business this is and go from there.
I agree that the bank is not a tax expert and should not be able to question the preparer.

When I was in the Air Force, I was told that there is the right way, the wrong way and the Air Force way.
Sometimes it is best to choose the third way instead of either the right way or wrong way.
In your case, in the future at least, I would prepare a schedule C or C-EZ. You would get no static from the IRS despite any of their instructions and would not have some banker or other person question it.

I had a sole proprietor client who always paid himself a salary and filed W-2s. This caused him to pay SS tax even when he showed a loss on his Schedule C. The IRS did not offer to change it and refund his overpaid SS even when he got audited one year when he had a loss. I've also seen the same with partnership returns with W-2s to partners.
It is NOT right, but the IRS won't complain and bankers have never complained.

[Maribeth]

In situations like this, and I do have a couple, I place the 1099 income on Schedule C; I have a deduction for the entire amount saying something like "Form 1099 issued in error", and the Schedule C has zero income.

Then the 1099 income goes on Line 21 and NO SE tax is calculated or paid.

Maribeth

[taxmandan]

Bank is having a cow over $1,500?

I would respond to the bank that the tax return was prepared to accurately determine tax due and flied with the appropriate tax authorities (IRS & state). Any other use of that return in ill advised and contrary to the IRC.

I would ask what their problem is, with the way the return was done. Put the monkey back on them to explain why there is a problem for them and how this is such a problem, I mean 5% of his income? Really?

[FEDUKE404]

Now I AM confused...

If you want to call the IRS instructions a minority opininion, then maybe I might have to agree.
The question lies in whether the income came from a small business or sporadic, not to be repeated regularly, income. If it does NOT qualify as a business then it should be reported on line 21, without the SE. If it qualifies for SE it should have been on the Sch C.

The minority opinion was referring to the TaxBook board members who have earlier provided input on this general topic. No reference, other than your own, was ever made to calling the IRS instructions such.

So just to clarify: If someone has several thousand dollars of consulting income, and it is reported on a Form 1099-MISC, you would just report it on line 21 in the same manner as if it were jury pay or similar and not even bother with a Sch SE?? And you would also do the same for a school teacher who during the summer gets paid a one-time $1k to tutor a friend's child to help with upcoming SAT testing?

OTOH - Maybe I should just "go out of business" every April and reopen in mid-January. Do you think that would fly as "sporadic" and save me a bundle on some Sch SE expenses??

FE

[Davc]

The dollars involved are not determinative.

For the consultant, 1099 income would probably be SE income since you're unlikely to be hired to consult outside of your usual field.

For the teacher I'd say SE since tutoring is teaching.

[JohnH]

Sounds like the bank doesn't want to make the loan and is looking for any lame excuse. In order to avoid telling the client they don't want his business, they're trying to muddy the water with this little ploy & leave the client angry with the preparer rather than the bank. Pretty creative - it might just work.

[AJsTax]

The minority opinion was referring to the TaxBook board members who have earlier provided input on this general topic. No reference, other than your own, was ever made to calling the IRS instructions such.

So just to clarify: If someone has several thousand dollars of consulting income, and it is reported on a Form 1099-MISC, you would just report it on line 21 in the same manner as if it were jury pay or similar and not even bother with a Sch SE?? And you would also do the same for a school teacher who during the summer gets paid a one-time $1k to tutor a friend's child to help with upcoming SAT testing?

OTOH - Maybe I should just "go out of business" every April and reopen in mid-January. Do you think that would fly as "sporadic" and save me a bundle on some Sch SE expenses??

FE

My reference to minority opinion was in reply to your statement that you thought the minority feel that an amount in box 7, 1099 misc should not automatically go on a Sch C and I am saying the IRS instructions must be in your opinion a part of the minority because they back up my position.
Like Davec said, the amount of dollars is not the determining factor.
The instructions for the Sch C state that the C can ONLY be used for a business, and states that an activity is a business if the primary purpose is for income or profit, and the taxpayer is involved in the activity with continuity and regularity.
Now, each case has to be decided on the facts and circumstances that are known for them.
There are many seasonal businesses that are considered businesses because they will be run on a regular basis, just not every day.
The case as stated with the teacher tutoring one student, no , it is not a business unless she does it on a regular basis and continues over time with others. Her other job is just that, a job as a teacher, not a business so there is not continuity there. Report her income on line 21 with no SE, IF she does promote herself out to be in business.

In the case of the consultant there is no way to know with the facts given.
One of the major court cases that proved this point had a man that was retired being hired by a friend to replace many windows in a commercial building over several months for many thousand dollars. The man never did not do that work before or after. The judge decided he was not in business and not liable for SE tax, but on the other hand could not deduct his costs on a Sch C and take a loss. It was line 21 hobby income with no SE and expenses only on Sch A with the 2% haircut, which he could not use because he did not file a Sch A.

So just because a sum is in box 7 does not mean it goes on Sch C, I don't care what we have been taught for so many years. There are often Spifs that are reported in box 7 instead of box 3 and the IRS even has a special report on those to show them in line 21.

[FEDUKE404]

Teacher query

Ok - so I am curious.

Employee W2 school teacher tutors a lone student over the summer. You say such income is not subject to self-employment tax.

Would teaching student #2 cross the threshold? And what about #3? Or #7?

Let's say, for whatever reason, the one and only time she provides tutoring/SAT mentoring she uses her den and teaches ten students at the same time during the summer break. Does she still get away with the "I don't regularly do this" and/or "I just did it once!" exception??

Somewhere along the line many (I'll avoid any further reference to "majority" for now) tax professionals would treat all such as self-employment income. I would likely treat it as such for student #1. So where, if ever, would you treat the teacher's additional income as self-employment income?????

The hobbyist putting up the windows seems to be the most commonly cited example for those who do view such income as exempt from Sch SE taxes. Apparently the logic is the "new" and/or "one-time event" excludes his income from Sch SE taxes. To a certain extent that is a split decision: It was not a business (downgraded to hobby) and he was apparently "helping a friend." That is pretty much a very specific mine field to negotiate and is separate from what most people do to generate income that shows up on a Form 1099-MISC.

I would love to see someone who tries to be more creative and works a couple of months in a "new" business installing windows, then works a few months later doing landscaping, then decides to try auto repairs, and then...... Do you really think that person could escape all self-employment taxes on the income?

I guess I must be having a most difficult time understanding the phrases "earned income" and "employment."

Time now to move on......

FE

[Gary2]

Let me add another twist to the teacher scenario: Suppose a teacher proctors the SAT twice a year, every year. There's no effort to get more proctoring jobs, no real effort into getting the same gig each year, no expenses, and no guarantee it will be there the following year. And I vaguely recall that there were special provisions allowing the testing service to pay such proctors on a 1099-MISC, even though they'd seem to meet the requirements for being employees.

[Burke]

Sounds like the bank doesn't want to make the loan and is looking for any lame excuse. In order to avoid telling the client they don't want his business, they're trying to muddy the water with this little ploy & leave the client angry with the preparer rather than the bank. Pretty creative - it might just work.

John, you may be right. But the banks are scared to death to make loans and are requiring the most ridiculous nit-picking detail about everything on the tax return to qualify them. Since most of them don't keep the loans anyway, it may be the "investors" buying the loans making the demands. This is the explanation I got last year when applying for a modest loan which was less than 50% of the value of the underlying property. They have made a 180-degree turn from the Liar Loans of the past decade, to examination of income right down to the mortgagee's socks. (Like it guarantees future income.) If you haven't read it, pick up a copy of The Big Short, a very enlightening book about Wall St and the subprime mortgage mess.

[DaveO]

Interesting discussion so far. I have a client who is a Chiropractor and makes a very good living at it. He also has a young son who loves baseball. So dad agrees to help out with the son's team which is sponsored by a local youth sports group. At the end of the season the Dr. gets a 1099MISC with $2500 reported as non-employee compensation.

The Dr. has no experience coaching baseball although he did play as a child. His motivation is to spend quality time with his son. He certainly is not giving up $150 per hour to coach a kids baseball team so there is no profit motive.

Most of the money is spent on fuel to travel to practice and games and for pizza and pop after the games. I listed the income on Line 21 and took no expense on the "A". He recently received a CP2000 asking for the SE tax.

I made the points in my reply that there is no profit motive, he is making no attempt to get more coaching jobs and his involvment will cease when his son stops playing.

I'll post the IRS answer when I get it.