Do you have to issue 1099s for work done on a rental

[Bobby Brown]

My wife and I were told that we must issue 1099s for any work that is done by independent contractors over $600 or we may be fined by the IRS (~$100-$600).  We so often find a big push back when you request to do this with contractors.  Of course they don't want to pay taxes on it, but why is that on me? Does anyone have experience with this? Will we have to pay a fine in order to claim the expense if we don't? Thanks

[Linda Weygant]

The code on this is actually a little bit grey.

Businesses who hire contractors are required to issue 1099s, but the grey area comes into play when you consider that you may own your property in your own name.  There are those who would advocate and say that because you are an individual, you do not have the 1099 requirements because you are not "in business" because rental property is passive and there are those that will argue the nuance of a passive investment vs being "in business."

However, there are also those who would say that if you yourself are an independent contractor and file those taxes on a Schedule C, you are most assuredly "in business" and that you are required to issue 1099s, even though the reporting mechanism is essentially the same as the first example above.

So what to do?

For me, the key is in looking at the Schedule E that you use to report your rental activity.  There is a question there that asks "Were you required to issue 1099s?" and a second question that says "If so, did you?"

To me, that indicates that, at least in the IRS' mind, you are required to issue the 1099s. 

So what happens if you don't.

For each 1099 that you were supposed to issue and did not, the IRS can assess a penalty.  If they determine that you neglected to issue them "willfully and knowingly", the penalty can increase.  

You can frequently get out of the penalty after it is assessed by swearing that you are now fully aware of the law, that you swear you won't break it again and that you are implementing policies and procedures now so that you will always be able to issue your required 1099s in the future.  You can do this once, and part of your policy/procedure needs to state that you will always ask for the contractor's 1099 status and paperwork BEFORE they start work and, most especially BEFORE you issue payment to them.

In essence, you agree to hold their payment hostage in return for the paperwork.

What happens if they give you a phony social security number (or EIN)?

You will get a notice from the IRS indicating that there is a name/ssn mismatch and ask you to correct it.  If you reply back and say that you have lost touch with the person and can't correct it, then you will likely be ok.  But now you cannot subsequently use that same person because if you try to use the same mismatch again, the IRS will recognize that and issue a fine to you.

It does suck that there are so many contractors out there dodging their taxes that the IRS had to come up with such draconian measures to gain greater compliance.

But also, ask yourself this.

If your contractor is skirting the tax filing requirements, what other corners are they cutting?  Are you sure they're license is current?  How about their insurance?  Do they have any?  Are you sure?  What about their employees?  Have they paid workers comp insurance?  If not, what happens if one of your contractor's employees (or your contractor himself) is injured on your job site?  (Hint - it's not good for you).  And last but not least, what corners are they cutting in the quality of the job they are doing for you?