Information returns for fun and vengeance

Image by nickwheeleroz (on holiday) via Flickr

Information returns, like 1099 forms, are meant to help the tax system work by enabling the IRS to make sure that income gets properly reported.  The IRS matches the information returns against 1040s and sends friendly "Dear Taxpayer" letters if they don't match up.

Creative taxpayers have found information returns useful for other things. Like vengeance.

After the breakup of his marriage, an ex-son-in-law still owed money to his ex-wife's mother.  Ex-Mom and Ex-Son never could work out a settlement, so Ex-Mom gave up on the debt -- and reported it to the son as "cancellation of indebtedness income" on a Form 1099-C filed with the IRS.

Ex-Son was unhappy with this - so unhappy that he sued Ex-Mom, claiming the 1099-C was fraudulent because the tax law didn't require her to send him one.  The court sided with Ex-Mom, saying the tax law doesn't mind too much information reporting.

That's a lesson entrepreneurs can take to heart.  The penalties for failing to issue information returns can get expensive in a hurry, starting at $50 for each failure to file them on time.

The tax law requires businesses to issue many information returns. Common ones include:

• W-2s to employees
• 1099-MISC to non-employees who receive $600 or more in payments from the the business during the year.
• 1099-INT to recipients of $10 or more in interest from the business during the year.

There are broad exceptions to the requirement; the biggest one is that most payments to corporations are exempt from the reporting requirements.

The 1099-C issued to report debt forgiveness by the Ex-Mom is required only of a "...governmental agency, a financial institution, or other organization in the business of lending money." But there's no penalty, other than preparation costs, of issuing an extra 1099.  Missing just a handful of those you do need to issue, however, can cost thousands.  The IRS requires many of these to be filed electronically; the penalties for failing to file the right way can be as high as for not filing at all (to be sure, there are serious penalties for maliciously filing false 1099s).

Check with your tax pro to learn more about information return requirements, and visit "A Guide to Information Returns" on the IRS website.

Oh, and think twice before borrowing from your mother-in-law.