Missing Form 1099 May Establish Reasonable Cause

In general, if you do not receive a Form 1099 to report income to you and you omit it from your tax return, you may still be liable for penalties if the IRS later notices the issue and makes an adjustment. This is because taxpayers have a responsibility to report all their income, regardless of whether they receive a Form 1099 or not.

The case of Mabinuori v. Commissioner, T.C. Summary Opinion 2006-109, is an example of this situation. In this case, the taxpayer did not receive a Form 1099 for income received from a part-time job, and therefore, omitted it from their tax return. The IRS later discovered the issue and made an adjustment, assessing an accuracy-related penalty against the taxpayer. The court did not agree with the IRS as to the penalty, however.

Facts & Procedural History

The taxpayer is employed by MetLife. He was first hired by MetLife as an independent contractor and subsequently hired as an employee.

MetLife had issued the taxpayer a Form W-2 for his wages as an employee and a Form 1099-Misc for his non-employee earnings.

MetLife issued Form 1099-Misc to the taxpayer’s old address.  This resulted in the taxpayer not including the Form 1099-Misc income on his tax return.

The IRS discovered the issue on audit, adjusted the taxpayer’s income accordingly, and imposed penalties.  The taxpayer disputed the penalties imposed by the IRS, which was the subject of the court case.

About the Accuracy-Related Penalty

The “accuracy-related penalty” refers to a penalty imposed on a taxpayer when they underpay their taxes due to negligence or disregard of the tax laws and regulations.

This penalty is meant to encourage taxpayers to take reasonable care in preparing their tax returns and comply with the tax laws.

The rules for the penalty are found in Section 6662(a). The penalty is 20% of the portion of the underpayment attributable to negligence or disregard of tax laws and regulations.

There are some exceptions to the accuracy-related penalty. The primary exception is reasonable cause. According to Section 6664(c), a taxpayer can avoid the penalty if they can demonstrate that there was “reasonable cause” for the underpayment and they acted in “good faith” with respect to the underpayment. This means that the taxpayer must show that they had a justifiable reason for the underpayment and that they made a genuine effort to comply with the tax laws.

Form 1099 May Be Reasonable Cause

The IRS is authorized to not impose (or abate or remove) penalties for adjustments if the taxpayer acted with reasonable cause.

The general rule is that failure to receive a Form 1099 is not necessarily “reasonable cause” for failure to report income. As a result, taxpayers who do not receive Form 1099’s are generally liable for penalties on the unreported 1099 income.

There are a number of court cases that support this conclusion. There are also a few court cases where the court found that the taxpayer was not liable for penalties that resulted from unreported 1099 income.

In this case, the court found the fact that MetLife had mailed the 1099 to the taxpayer’s prior address and the W-2 to the taxpayer’s current address significant. It also found that the taxpayer may have reasonably believed that part of his MetLife income was reimbursement for the costs of setting up an office. These factors led the court to side with the taxpayer in concluding that he had reasonable cause for his failure:

With respect to the self-employment income, petitioners did not receive the Form 1099-MISC, which was sent to their former address. We have held that failure to receive a Form 1099-MISC does not necessarily constitute reasonable cause for failure to report income. See Goode v. Commissioner , T.C. Memo. 2006-48; Brunsman v. Commissioner , T.C. Memo. 2003-291 (taxpayer “did not need to receive a Form 1099-MISC to be alerted to the fact that he received compensation from * * * [a third party] for his services.”). In this case, however, we find it significant that petitioners received a Form W-2 from MetLife. Petitioners may not have understood the distinction between wage income and self-employment income; i.e., that they should have received a Form 1099- MISC for the earnings during the training period. Thus, petitioners could have reasonably concluded the Form W-2 reported the entire earnings from MetLife in 2002. It is arguable that petitioners should have noticed their gross income was understated by $6,005. However, petitioners believed that a significant portion of this amount was reimbursement for office expenses and, therefore, excludable from gross income. The facts present a close question, but viewing the record as a whole, we conclude that petitioners have demonstrated reasonable cause for failing to report the self-employment income and that they acted in good faith. See sec. 6664(c). Accordingly, they are not liable for the accuracy-related penalty with respect to this adjustment.

While the court sides with the taxpayer, it notes that “the facts present a close question.”

The Takeaway

Taxpayers have a responsibility to report all their income, even if they do not receive a Form 1099 to report it to them. Failure to do so can result in penalties and interest assessed by the IRS. However, there are some exceptions to the accuracy-related penalty, such as reasonable cause. Taxpayers can avoid the penalty if they can demonstrate that there was reasonable cause for the underpayment and they acted in good faith with respect to the underpayment. While the general rule is that failure to receive a Form 1099 is not necessarily reasonable cause for failure to report income, there are some exceptions. This court case is an example of that.