allowances paid on 1099

[diver000]

My new employer pays me both a salary(W2), and allowances(1099). My co-workers say they operate as a business for the 1099 income - with offsetting expenses, i.e., home office, mileage, etc. The allowances I am paid for are vehicle, fuel, healthcare ins.(I provide my own), and phone(I use my own). My question is can I operate as a business for this 1099 income as a construction project consultant? I still have a Texas LLC - I would just have to change the SIC code.  Would I suffer the cost of the self-employment tax?

[Anonymous]

your company and your friends and you if you follow along are playing a dangerous game. 

The IRS and the U.S. Department of Labor have specific criteria for determining who is an employee and who may be classified as an independent contractor. These criteria focus on the overall relationship workers have with their employer. Workers who are economically dependent on an employer and look to that employer to tell them how and when the tasks that make up their job are to be done are employees. Workers in business for themselves who retain more control over how the finished product is achieved are independent contractors.

The government is cracking down on misclassification of workers. Classifying a worker as both employee and contractor can be a red flag for the IRS. When filing taxes, the individual will be reporting wages earned (via a W-2) as well as earnings as a self-employed individual (via a MISC-1099) which may invite an IRS investigation into the actual circumstances.

if you go the both routes and have net schedule C income you'll pay SE tax.   in addition you may be eligible for the QBI deduction.  taking it can cause substantial problems if the IRS catches you and not taking it can cause another red flag with the IRS.    

the penalties, if caught, can be enormous.  failure to withhold and pay payroll taxes can result in a 100% penalty for the employer.   for the employees the 1099 income would be converted to wages and the expenses they deducted would be disallowed. 

thus they could have substantial underpayment penalties

there maybe an out.      your employer should consult with a tax professional about the possibility of setting up  a reportable expense reimbursement plan.    if it can be done,  employees submit expense reports for which they're reimbursed.   the employer gets to deduct the reimbursements while the employees report nothing.      I warn, that not everything your employer is reimbursing you for would qualify, but some is better than none.

one more thing to consider.  should one of these employees be fired or anyone else that knows of this scheme,   they can report this to the IRS to get a financial reward.    if someone decides to report this properly as wages,  I would expect the IRS to contact the employer.   If the IRS doesn't like the answer, there is a possibility it will audit the employer.         

[Hal_Al]

In the old days (2017), you employer was required to report expense "allowances" (as opposed to the actual reimbursement of documented expenses) as income on your W-2.  You would then take an itemized deduction for  job expenses.   You only got to deduct that portion of  your misc deductions that exceed 2% of your AGI. and then only if your total  itemized deductions exceed the standard deduction.  But, you did get a deduction.

Beginning with tax year 2018, all miscellaneous itemized deduction, subject to the 2% of AGI rule were eliminated, including job expenses.  It sounds like your employer may be trying to get around this rule by reporting the expenses on a 1099-Misc  (the self employed do get to deduct job expenses, by calling them business expenses).

It would be rare, but depending on the nature of your work, this arrangement might be OK. Typically the requirement is that the nature of your activities being reimbursed  must not be directly related to your regular job duties.

Furthermore there are special rules about deduction health insurance*, phones** and home office***.

That said; the IRS expects income reported in box 7 of a 1099-Misc, to be reported as self employment income. 

The IRS considers anything in box 7 of 1099-MISC to be self employment income.  If you try reporting box 7 income as anything else, you chances of hearing from the IRS are very high.  So, you should probably go ahead and report it that way.  You will pay self employment tax if the allowances exceed your expenses.

*Health insurance for the self employed is reported on Schedule 1, not Sch C, so  it cannot reduce your self employment tax. It will be hard to justify it as self employed  insurance and should actually go on Sch A

**The costs of a cell phone  may be a business expense, but only the additional costs in using a cell phone for business are deductible. If you pay a flat rate on a phone used for business and personal calls, the tax court has held that the flat rate is for your personal phone and you incurred no additional charges for business use. You have no deduction.  A land line to your home is never deductible (except itemized call charges).

***A home office must be your principal place of business.

As HACKITOFF says; you should probably review this situation with your employer. 

[Hal_Al]

If you are a "Statutory Employee", see https://ttlc.intuit.com/community/taxes/discussion/reporting-statutory-employee-income/01/392701#M16...

[TomD8]

Hopefully your employer is aware of this IRS rule:

Do not use Form 1099-MISC to report employee business expense reimbursements. Report payments made to employees under a nonaccountable plan as wages on Form W-2. Generally, payments made to employees under an accountable plan are not reportable on Form W-2, except in certain cases when you pay a per diem or mileage allowance.

https://www.irs.gov/pub/irs-pdf/i1099msc.pdf

This IRS reference explains accountable vs nonaccountable plans: https://taxmap.irs.gov/taxmap/pubs/p463-012.htm#TXMP3a1f7e37

[rjs]

As TomD8 has pointed out, your employer is reporting the allowances incorrectly. All payments from an employer to an employee should be treated as wages and included in the employee's W-2.

The correct way to report the allowances on your tax return, in spite of your employer's error, is to include the allowances in the total wages on your return, and include Form 8919 in the return, with reason code H in column (c). This form is specifically for income that was reported on a 1099-MISC but should have been included in your W-2. Form 8919 will calculate the Social Security and Medicare taxes that your employer should have withheld from the allowances. The total of these taxes will appear on Schedule 4 line 58 and will be included in your total tax liability. The allowances will be included in the total wages on Form 1040 line 1. On the dotted line to the left of the amount on line 1 there will be a notation "F8919" and the amount of the allowances. Below are detailed instructions for doing this in TurboTax.

The allowances are additional taxable income. Since you are an employee, you are not allowed to claim a deduction for any job-related expenses. If your employer is going to continue incorrectly reporting the allowances on Form 1099-MISC every year, you might want to consider paying extra tax during the year so that you don't get hit with a big payment due on your tax return. You can either adjust your W-4 to have your employer withhold additional tax from your pay, or make estimated tax payments. You can use the IRS Tax Withholding Estimator to figure out what to put on your W-4 form.

IRS Tax Withholding Estimator

To report the allowances correctly, follow the steps below to enter the 1099-MISC in TurboTax.

• Click the Federal Taxes tab.
• Click Wages & Income.
• Click "I'll choose what I work on" or "Jump to a full list."
• On the screen "Your 2018 Income Summary," scroll all the way down to the last section "Less Common Income." Click the Start button for the last topic, "Miscellaneous Income, 1099-A, 1099-C."
• On the next screen click the Start button for "Other income not already reported on a Form W-2 or Form 1099."
• The next screen asks "Did you receive any other wages?" Select Yes and click Continue.
• The next two screens ask about household employee wages and sick or disability pay. Click Continue on these two screens without entering anything.
• The next screen asks "Did you earn any other wages?" Select Yes and click Continue.
• The next screen asks the source of the other earned income. Select "Employee compensation that was not reported on a W-2." Ignore the note that says not to enter compensation for which you will receive a 1099. Click Continue.
• On the next screen, "Employee Compensation Not Reported on a W-2," click Continue.
• If you are filing a joint return, you will get a screen asking which one of you the income is for. Select your name and click Continue.
• On the next screen, "Report Your Wage Income," enter the employer's name and EIN from your W-2. When entering the EIN, you must enter the hyphen after the first two digits. For Total Wages Received, enter the amount on the 1099-MISC. Select Reason Code H. Click Continue.
• On the next screen, "Report as Wages," click Done.
• This returns you to the Miscellaneous Income screen. Click Continue.