Incorrect 1099-NEC Received From Payee/Client

[fanboy]

My wife is a freelance writer. She received a $2,000 advance payment in full from a payee/client, and the work was to be completed by June 2021.

Due to an upcoming move, my wife does not have the time to complete the work by June 2021 so it was mutually agreed that the wife would return the $2,000 to the client/payee, which she just did.

The client and wife agreed they would begin working on the project again later this year.  The wife has worked for this person a lot over the past few years, so the returning of the $2,000 is mutual.  The wife did not start the project yet either.

However, the wife just received the 1099-NEC from the client, and the 1099 includes the $2,000 payment in the total sum.  The wife contacted the client and he said he cannot change the 1099; that it will just roll over to 2021 since they plan to continue working on the project again later this year.

The wife said she didn't see that being correct because what if the client or wife were to die, or something changes where the client no longer wants or needs the wife's services for this project.

I've been self-employed my entire life and when I receive an incorrect 1099, and the payee is non-responsive, I simply download form 1040X (?) and make the adjustments myself.  I've received incorrect 1099's several times over my 30+ years being self-employed and I never ran into an issue doing this.

So... just looking for some current advise as I haven't had to request a 1099 correction in a long time.

Thank you!

Frank

[Mike9241]

court cases including those before the SCOTUS have ruled that advanced payments are taxable in the year received when the only obligation to return the money is if the goods or services are not delivered or performed.  thus the 1099 is correct it is taxable in 2020.  had the money been returned in 2020 then it would not have been taxable.  

[fanboy]

Thanks Mike! 

So then, the wife should not return the money if the services will still be performed in 2021. The wife has not yet mailed the check.

The client's daughter is his accountant so I surmise she'll suggest that the wife keep the money since the services will still be performed.

Frank

[Opus 17]

If the money is returned in 2021 and never repaid, then it is a deductible expense in 2021 as a refund.  But it is still taxable income for 2020. How you handle the re-payment and re-repayment or just hold onto it is between your wife and the client.

[fanboy]

Hi @Opus 17 /members. 

We ended up returning $7,000 in 2021 for payment received in 2020 (job basically got cancelled).  So we paid taxes on that $7,000.

You mentioned we would deduct the $7,000 as an expense in 2021, but is there a specific form we should use so the IRS knows that we returned the money to that specific business who paid us? 

We're not sure where we would place that number in our 1040, or will TurboTax prompts us at some point.

Thank you and yes, I'm starting to tally up my expenses for the year already! 😉

Frank

[Opus 17]

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@fanboy wrote:

Hi @Opus 17 /members. 

We ended up returning $7,000 in 2021 for payment received in 2020 (job basically got cancelled).  So we paid taxes on that $7,000.

You mentioned we would deduct the $7,000 as an expense in 2021, but is there a specific form we should use so the IRS knows that we returned the money to that specific business who paid us? 

We're not sure where we would place that number in our 1040, or will TurboTax prompts us at some point.

Thank you and yes, I'm starting to tally up my expenses for the year already! 😉

Frank

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Customer refunds is one of the categories of expenses on schedule C (line 2, in fact).  Turbotax should ask about any refunds when you prepare your wife's schedule C for her consulting business.  You don't have to show the IRS which specific business you refunded on your tax return.  That will reduce your taxable income for 2021 so even though you paid more tax in 2020 (by including income for a job that was cancelled) you pay less tax in 2021.

[VolvoGirl]

@Opus 17   Just thinking.....what if the return is more than the income reported in 2021?   Can you have a negative gross income on line 7?   Since it's for different years I might be inclined to add it as a misc expense with a description.

[Opus 17]

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@VolvoGirl wrote:

@Opus 17   Just thinking.....what if the return is more than the income reported in 2021?   Can you have a negative gross income on line 7?   Since it's for different years I might be inclined to add it as a misc expense with a description.

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Why not?  If you were a store and you had a clearance sale or going out of business sale or were selling below cost to build your business (*cough*Amazon*) your COGS might be more than your revenue.  

I'd be inclined to list it as a refund and see if Turbotax complains.  (It also depends on whether the consultant did other work in 2021, in which case there wouldn't even be a negative number.  The taxpayer hasn't told us about their whole business, just this one client.)

[fanboy]

Thanks folks for your replies. 

The wifey did earn income in 2021, some from the same payor and some from other business too, so it will total more than what we returned.

I tend to overthink things, which isn't good especially in subjects I know little about.  But I just find it strange that a company can pay someone at the end of a year, claim it on a 1099-misc, then cancel the job soon into the following year so the "deposit" is returned, but there's no reference to the IRS regarding that. 

I'll keep you posted though after the New Year to let you know how TT responds.

Thanks all!

Frank

[Mike9241]

maybe that company is running a tax scam on the IRS. makes payment and issues 1099 to take a deduction in year 1 knowing they'll cancel early in year 2 and get the money back. repeat in future years to they can get to whatever taxable income they want.   not knowing if you can do this with your customers, but perhaps making part of any deposit non-refundable or maybe only with new ones.

[fanboy]

Not a scam, but a personal longtime friend of the wife's. It's a small company, but it still bothered my thinking that his company didn't want to re-issue a corrected 1099 since we were only in the first month of 2021 when we received the 1099.

[Opus 17]

@fanboy 

They can’t legally change the 1099 because both you and the other business are cash basis taxpayers. If the money was actually paid in 2020, that’s what has to be on the 1099. If it was returned in 2021, that is dealt with on the 2021 tax return.  You are making the appropriate adjustment on your tax return, and they are supposed to make the appropriate adjustment on their tax return.  Fewer than 1% of tax returns are audited, so everyone‘s basically on the honor system. If you really think they are tax cheats, there is a form you can use to report suspected fraud.