Let’s say you’re self-employed, and you get a 1099-MISC from a customer. He notes he paid you $1,200. However, he really paid you $900. What do you do?
First, you contact the customer and attempt for him to correct the error. Hopefully, you can show him a copy of your invoice(s) or other documentation, and he or she will issue a corrected 1099-MISC.
But what if he refuses? Here, practicality must be used. Let’s say the total of your gross receipts is $32,000, and the total of your 1099-MISCs (and 1099-Ks) is $29,000. I’d likely just enter the 1099-MISC as received, and lower the “other” gross receipts by the extra $300. (IRS instructions on information returns state to use the actual number. The problem is that the automated underreporting (AUR) unit will almost certainly send you a notice if you use the wrong number.)
Earlier this week I was faced with a different situation. My client, an amateur gambler from Indiana, entered a poker tournament in Iowa. The tournament had a $300 buy-in, and my client cashed for $2,300. Under federal law, no W-2G would be issued because the amount of his win, $2,000, is less than the threshold for issuing a W-2G in a poker tournament ($5,000). However, under Iowa law withholding on nonresident’s winnings begin at gross winnings of $1,200 (at a rate of 5%). My client received a W-2G for $2,300, not $2,000. What should be done? (My client has excellent records, including the tournament buy-in receipt.)
The amount of the win is $2,000, not $2,300. Indiana does not allow gambling losses to be deducted on their state income tax returns, so this is an issue for my client. (This can be an issue for individuals on federal returns, too. Gambling losses are an itemized deduction, so they don’t impact Adjusted Gross Income (AGI). Many tax items are tied to AGI, such as being able to contribute to a Roth IRA.) However, if I enter $2,000 as the amount won for that W-2G, the IRS’s automated underreporting unit will flag the return.
The solution is to enter the W-2G as it was received, and then subtract out the $300 buy-in just below this. I included an explanation: “Buy-in for W-2G winnings.” Should the IRS, Iowa, or Indiana flag the return, we can respond with a perfect paper trail showing that what we did is to put the income my client really earned on the tax return. Given that this is a fundamental principle of US taxation, all should be well.
The same process can be used for other information returns that are erroneous: Enter the “wrong” numbers, and modify them with an explanation. Do realize that there is a chance that the AUR unit may ask for proof. This is yet another reason why the solution to many tax issues is to document, document, document.