Information reporting matters
Information reporting is a major issue for the IRS these days. It's likely to be a topic of discussion whenever they conduct an audit of a financial institution. The reason for this is clear: the current Congress views information reporting as an essential means for generating revenue in a time of budgetary shortfalls. Banks need to prepare for what may be a protracted legislative mandate, and devote time to understanding the IRS mindset on information reporting and which requirements are of greatest interest to them.
In this article, we will look at some of the major information reporting matters that financial institutions need to understand, including:
- Expanded 1099 reporting requirements
- Frequent flyer miles
- Increased filing penalties
- Cancellation of debt
- Reporting organizational actions
Expanded 1099 reporting requirements
One effort by Congress to raise revenue through information reporting reforms was its recent attempt to expand Form 1099 filing requirements. Congress hoped that this measure would identify income not currently being reported. By broadening the income subject to reporting, legislators hoped to use the additional tax collections to fund part of the mammoth health care reform bill. The law with a provision for expanded 1099 reporting requirements was passed in March 2010 as the Patient Protection and Affordable Care Act. Among the changes passed in this bill were the following:
- Expanding the reportable payments definition to include purchases of property, as well as services
- Requiring that payments made to corporations or individuals be reported on
However, this tax law change was vigorously opposed by various business interests, who argued that the cost of compliance would be astronomical for most companies. As a result of pressure from these groups, Congress repealed the law in April 2011, with the passage of the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act. Despite this overturn, banks should continue to monitor developments in this area and should not assume the idea is dead. Given the fiscal crisis the country is currently facing, it's possible that Congress will reintroduce the measure in the future.
Frequent flyer miles
Historically, frequent flyer miles have been viewed as a tax-free perk with no reporting requirement. But recent 1099 filings by a major bank have cast doubt on the issue. The incident could have major implications for banks that offer frequent flyer miles as an incentive for opening an account.
Recent informal IRS guidance describes the circumstances under which an organization may be required to issue Form 1099s to recipients of these incentives. In the words of an IRS spokeswoman, "When frequent flyer miles are provided as a premium for opening a financial account, it can be a taxable situation subject to reporting under current law." Here, you might say that the bank is in the same tax position as a radio station that gives away free sports tickets to the first 50 callers. In both cases, the promotion is viewed as a premium and as income subject to taxation.
However, if you receive frequent flyer miles for using your credit card, the miles would not be subject to taxation. In this case, they are viewed as a discount rather than a premium. Again, in the words of the IRS spokeswoman, "A common analogy is buying a $500 television at a retail store and receiving a $50 manufacturer's rebate. It's not income, just a deemed reduction of the cost of the television."
Nevertheless, it's worth noting the spokesperson's use of the words "can be a taxable situation" rather than "is a taxable situation" — a distinction which could leave the door open for further interpretation. At least one member of Congress has said they disagree with the IRS' position on frequent flyer miles, which hints at the possibility that legislation will be introduced to ensure that the miles are not treated as taxable in the future.
Increased filing penalties
Another recent change to the tax law involves the significant boost in penalties for various form filing violations. Beginning in 2011, penalties for late filing or for filing incorrect information on a 1099 form are levied on an escalating scale that has gotten much steeper.
- Late filing or incorrect information penalties are doubled, as follows:
- If filed or corrected by March 30 - $30 each, maximum
- If filed or corrected by Aug. 1 - $60 each, maximum
- If filed or corrected after Aug. 1 - $100 each,
maximum $1.5 million
- If filed or corrected by March 30 - $30 each, maximum
- Maximum penalties are three to six times higher than previous maximum penalties
- If a company's average gross receipts for the prior three years are less than $5 million, the maximum penalties are reduced by more than half
- A company can petition to have penalties abated if reasonable cause can be demonstrated for the alleged error
- Abatement of any penalty is at the discretion of the IRS and is
- Penalty abatement or waiver will likely be harder to achieve in
To understand how large these increases are, consider that penalties ranged from $75,000 to $250,000 under the old penalty regime. The huge increase in filing penalties promises to be a surefire revenue generator for Uncle Sam.
Cancellation of debt
Generally, the charge-off of a loan does not automatically generate the requirement to report the event to the IRS. Reporting of cancelled debt as income is required only for eight "identifiable events," as outlined in U.S. Treasury regulations:
- Discharge of indebtedness (bankruptcy) under Title 11 of the United States Code.
- A cancellation or extinguishment of an indebtedness that renders a debt unenforceable in a receivership, foreclosure or similar proceeding in a federal or state court.
- A cancellation or extinguishment of an indebtedness upon the expiration of the statute of limitations for collection of an indebtedness, or upon the expiration of a statutory period for filing a claim or commencing a deficiency judgment proceeding.
- A cancellation or extinguishment of indebtedness pursuant to an election of foreclosure remedies by a creditor that statutorily extinguishes or bars the creditor's right to pursue collection of the indebtedness.
- A cancellation or extinguishment of an indebtedness that renders a debt unenforceable pursuant to a probate or similar proceeding.
- A discharge of indebtedness pursuant to an agreement between an applicable entity and a debtor to discharge indebtedness at less than full consideration.
- A discharge of indebtedness pursuant to a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity and discharge debt.
- The expiration of the non-payment testing period.
As a general rule, reporting is required when the legal right to collect a debt or portion thereof is extinguished for less than adequate consideration.
Reporting organizational actions
The IRS believes that gains and losses reported on sales of securities are often incorrect. As a result, there have been recent changes in the tax law to address this problem.
- Issuers of stock and securities must report any organizational action that impacts the basis of the securities, including, but not necessarily limited to:
- Mergers and tax-free reorganizations
- Stock dividends
- Stock splits
- Non-dividend distributions
- The reporting must include identification of the affected securities and a detailed description of the impact the organizational action has on the basis of the securities.
- Reporting is required on two fronts:
- Reporting to each holder of record by Jan. 15 of the year following the calendar year in which the organizational action was executed.
- Reporting to the IRS within 45 days following the organizational action, or if earlier, Jan. 15 of the year following the calendar year in which the organizational action was executed.
- Both requirements can be satisfied by timely posting of the required information on the taxpayer's public website within 45 days of the organizational action and by keeping it there for 10 years.
For more information, please contact your financial services representative or Jerry Kissell, tax partner, Depository Institutions Group, McGladrey LLP, at 612.376.9886.