The Q Word

I can resist everything except temptation. Oscar Wilde

March 31, 2014

Comments and Advice to Help Improve the Tax Returns That We Prepare

PLEASE, DONT DO IT!

Heres the scene. Youre a volunteer who just finished preparing a tax return. As you start to raise your hand for quality review, the client pulls out one more crumpled piece of paper: a Form 1099MISC with $1,200 in Box 7, nonemployee compensation. On Form 13614-C the client has checked No to the questions about self-employment. When you ask about his business, he says he doesnt have a business; he just did a little work on the side. Youre flummoxed. Then you spy line 21 on Form 1040, Other income. Aha! You think: Miscellaneous income, other income, pretty much the same thing. Think again. It may be the easy way, but putting Form 1099-MISC, box 7, income on line 21 is almost never correct. There are three different ways to report Form 1099-MISC, box 7, income. 1. Put it on Schedule C-EZ or Schedule C. (almost always correct) 2. Put it on Form 8919, Uncollected Social Security and Medicare Tax on Wages. (sometimes correct) 3. Put it on Form 1040, Line 21, as hobby income. (almost never correct) 1 - Put it on Schedule C-EZ or Schedule C Nonemployee compensation income is almost certainly self-employment income, even if the client doesnt think of it that way. And it makes a big difference. Expenses related to earning the Income can be deducted on Schedule C-EZ/C, which reduces the social security and Medicare taxes, as well as the income tax. No self-employment tax is computed on line 21 income and it probably should be. Line 21 income is not considered earned income for the EITC or additional child credit. Reporting nonemployee compensation should be the default approach. This is not a matter of what is more beneficial to the client. If the situation does not fit into the other two possibilities (misclassification or hobby income) and it probably wont - the income is self-employment. It goes on Schedule C-EZ/C because that is correct! While were on the topic, take heed concerning these tricky Schedule C-EZ/C issues. Always ask if there is other income, such as cash, related to the activity. If there is, it also gets reported on the same Schedule C-EZ/C. Just link to a scratch pad from line 1. Getting to and from work is not deductible unless the client has business use of the home.
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In most cases exclusive business use is required for home business deduction. Unless the client is a home-based child care provider, it is unusual to qualify for business use of home. Clothing is not deductible unless it has a special restrictive use, such as a safety helmet.

2 - Put it on Form 8919, Uncollected Social Security and Medicare Tax on Wages When a worker has been misclassified as an independent contractor rather than an employee, the situation can be reported to the IRS and then the income is reported on Form 8919. The correct classification generally depends on the amount of control that the payer had over the worker and the way the work was done. Publication 1779, Independent Contractor or Employee, explains the guidelines for making this decision. Often one clue is the amount of expenses that the client had in order to do the work. When a worker with a Form 1099-MISC, box 7, says that he had no expenses related to that income, misclassification should be considered. Heres how the Form 8919 works. The worker files Form SS-8 to report the misclassification to the IRS. This form is filed separately from the tax return and cannot be filed anonymously. In other words, the payer will find out which worker reported the misclassification. If the client is working at the same place, reporting misclassification may not be a good idea. Remember, it is ultimately the clients decision. By using Form 8919, the income is taxed as if it were wages. On TaxWise, open Form 8919 by linking from Form 1040, page 2, line 57. Then link from Form 8919, line 1(f) to open Form 1099-MISC. TaxWise will compute the employees half of social security and Medicare taxes and it will be reflected as an additional tax on Form 1040, line 57. This is the payroll tax that shouldve been withheld from the workers pay and sent to IRS during the year. Form 8919 will ask for a reason code. In most cases, the worker will have recently filed Form SS-8 and the reason code will be G. When using Form 8919, do not report the income on a Schedule CEZ/C or on line 21. 3 Put it on Form 1040, Line 21, as Hobby Income When a taxpayer has nonemployee compensation, it is assumed that he was working to make money. But in some situations, there are other reasons personal reasons for doing the work. When that is the case, the income is reported on Form 1040, line 21. Publication 535, Business Expenses, lists factors to consider when determining if an activity is engaged in for profit. It lists such things as: Whether the activity is conducted in a businesslike manner. The time and effort put into the activity. If the taxpayer lives on the income. Whether the taxpayer actually made a profit. Here are some examples. An amateur bowler won $850 in a tournament. He will get a Form 1099-MISC, box 7, at the end of the year. But his motivation for bowling in the tournament was recreation and he has no expectation that overall his bowling activities will result in a profit or be his livelihood. The bowling income should be reported on Form 1040, line 21. Any expenses go on Schedule A. A grandmother is paid by the state to provide child care to her grandson. Her primary motivations are to help her daughter and spend time with her grandchild. To do this, she quit her regular job and tightened up her budget so she could live off the small child care earnings. She keeps careful records of her expenses. Although, her motivation is personal, she is determined to make a profit and the activity is paying her rent and buying groceries. The income should be reported as self-employment on Schedule C-EZ/C.
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Another grandmother is paid by the state to provide child care to her grandson. Her primary motivations are to help her daughter and spend time with her grandchild. She and her husband primarily live off of their social security and investments. She is not sure whether or not she is making a profit doing child care: She doesnt keep records and a profit is not important to her. She knows that she has some expenses related to taking care of her grandchild, but since their mortgage is paid off, they dont have enough to itemize. The income should be reported on Form 1040, line 21 and no deduction is taken for expenses.

It is quite unlikely that you will encounter hobby income that is, income from an activity not engaged in for a profit - at a VITA site. Dont hesitate to consult your site coordinator or refer the client to a paid preparer. In the unlikely event that you prepare a return with hobby income, heres how it works. The income is reported on Form 1040, line 21. Link from line 21 to 1040 Wkt 7. Enter any deductions related to the income as a miscellaneous deduction on Schedule A. Link from Schedule A, line 28, to the Other Deducts form. The deductions are not limited to the excess of 2% of AGI. However, the taxpayer must itemize to take any deductions. The deductions cannot exceed the income on line 21. Remember! Putting Form 1099 income on line 21 is almost always wrong. The only income we see with any frequency that goes on line 21 is gambling winnings. So, resist temptation and enter income on line 21 only when you fully understand the reason!

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The Q Word National Community Tax Coalition

March 31, 2014

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The Q Word is written to provide commentary, information, opinions and observations from a grass roots perspective to all preparers, managers, and coordinators that are involved in free income tax preparation programs. If you have any suggestions for the Q Word, or would just like to submit comments, questions, praise, or bitter criticism, please e-mail: Barbara DelBene at bdelbene@tax-coalition.org