2-2-07
Big Brother Is (Sorta, Kinda) Watching You
“Big Brother” wasn’t always just the title and the premise of a crappy reality television program. George Orwell coined the term in his book, 1984, for the leader of a totalitarian government which used advanced and pervasive technology to monitor every single person’s words and actions. Pretty chilling, too, when you realize that virtually none of the relevant technology had been invented when he wrote the book in 1948 – and that virtually all of it exists now.
Utopian and dystopian visions conveniently wave away issues of cost, manpower and operational reliability. Real governments cannot. Public acceptance aside, these issues become overwhelming.
Which brings us around to the Internal Revenue Service. Don’t think of it as Big Brother. Think of it as Big Brother’s Little Brother, the scrappy infielder rather than the steroided home run hitter.
Maybe with One Eye Closed
Since the early 1980s, the IRS has been trying to make tax enforcement less human-based and more computer-based. They are not trying to ensure perfectly accurate tax reporting, since 100 percent accuracy lies up an impossibly steep cost-benefit curve. But they believe that much of the enforcement needed for “accurate enough on average” can be done by automated processes. It has been a difficult project, with some costly failures, and still plagued by some serious limitations.
You can safely assume that any form you receive specifically for tax purposes the IRS has also received. You can also assume that the information on these third-party reporting forms will be entered into their computers – probably accurately.
Less certain is that it will be compared to the tax return you file.
Sometimes It Works Well
Oh, some certainly will be. W-2s, which show both the wages and the tax withholding from employment always are cross-checked. Leave out a W-2 and there will be a fun form letter from the IRS seeking an explanation and money.
Almost equally certain are dividends and interest, which will be reported on a form 1099-DIV or 1099-INT. You might not get a letter if the unreported amount is trivial; the tax on $10 or $20 of income is less than the cost of collecting it.
But some of the other forms, well, maybe.
Forms 1098 report not income, but a specific type of deduction: mortgage interest. In my experience, the IRS matches them more often than not. Certainly, I’ve seen many matching program notices based on them. But I just finished amending three years’ worth of tax returns for a new client who each year had managed to claim his mortgage interest twice, on different forms. (This is, by the way, a textbook demonstration of how one can screw up a tax return using consumer-level tax preparation software.) He has not heard one word from the IRS.
Sometimes It May Work
Of the 16 different types of forms 1099, the other one you are likely to receive is form 1099-MISC. You receive these for “fee” or “independent contractor” or any other euphemism for nonemployee compensation, but that is only one of a dozen types of income reported in different boxes on that form.
Matching forms 1099-MISC to income tax returns is a challenge for the IRS. First, many of these income items could be correctly reported in two or three different places on an individual return, and several may or may not be subject to self-employment (Social Security) tax depending on particular circumstances. Second, 1099-MISCs are issued only when the nonemployee compensation paid is $600 or more; accordingly the figure on any one of those tax return lines may be a mixture of income on 1099s and income not on 1099s.
Last, many 1099-MISCs are just plain inaccurate. I regularly see them with figures in the wrong box, or with amounts that are a weird, random jumble of fee income (which belongs on the 1099) and expense reimbursements (which do not).
Despite the challenges, the IRS will frequently issue mismatch notices based on 1099-MISCs; their accuracy is spotty.
And Sometimes We Just Don’t Know
The last group of third-party reporting documents are Schedules K-1, which report the recipient’s share of income and deductions from a pass-through entity, such as an S-corporation, partnership, trust or estate.
The IRS tried matching these to individual tax returns a few years ago, and the results were laughable or infuriating, depending on whether you were one of the people who received a grotesquely inaccurate demand for taxes or merely heard the stories. They quickly called off the project. Over the past few years, these forms have been completely redesigned to be like hypertrophic W-2s: lots of numbered boxes, some of which have multiple letter sub-designations. The goal was to leave little or no ambiguity about where any line on a K-1 should be entered on the recipient’s tax return. Uh-huh. Right. We’ll see. The first matching notices from the redesigned forms are only now coming out.
Just Remember This
Schedules K-1 have to wait till the underlying entity has filed its income tax return. All the other forms should be in your hands right now, as the deadline for mailing them to you was Jan. 31. Gather them and check them now. If they are wrong, ask the payers for corrected ones; don’t worry, you will not be the only one calling.
Similarly, if you should have received a W-2 and have not, call now. It may well have been sent to an obsolete address even if the checks were sent to the right one.
And last, remember that Little Brother is only seeing what’s on these forms; he’s not seeing everything that goes in or out of your bank account (though his cousins at the National Security Agency might). You – and only you – are responsible for reporting all of your income, and reporting it accurately. Little Brother is just helping you resist the temptation to cheat.
Free Offer
If you would like a copy of my free “Checklist of Potentially Deductible Items” for those in the arts, just write, call or e-mail my office. We’ll be pleased to send you one.
Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or call 773/525-1778 (888/525-1778 toll-free outside the Chicago area) or e-mail greg@gregmermel.com.
Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He has also been known to produce theatre.