Over at Bogleheads we read: Subcontractor labor, 1099 and tax deductions
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Subcontractor labor, 1099 and tax deductions
by xanadu32 » Sat Dec 21, 2013 9:47 pm
Hello,
I run a small IT services LLC in Maryland (accounting run on actual basis). I use sub-contractors and I have a question regarding 1099 and tax deductions.
I am sending my sub-contractors a check on Monday for the services rendered in October 2013 (Net 45 payment terms). I am assuming they will receive the check by the end of the week (around 12/26).
I know I have to include the payment in the 1099 I issue for 2013 (because I issued the check in 2013). But if the check issued doesn't clear my bank account by 12/31, can I claim tax-deduction on the amount that I paid? Basically, should my 1099 match the sub-contractor labor amount that I deduct in my tax returns (Schedule C) ?
Similarly, I issued another check couple of months ago and my sub-contractor didnt present the check in the bank yet. Again, I will include that amount in his 1099 but the same question remains - the amount didn't leave my bank account. Can I deduct it?
Thank you. This is my first year using sub-contractors and I am using a firm for my taxes but I am just curious. And, wanted to educate myself using the responses below before I contacted the CPA on Monday.
Thank you in advance. Appreciate the response and happy holidays to everyone!
- xanadu32
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Re: Subcontractor labor, 1099 and tax deductions
by Jack » Sat Dec 21, 2013 10:51 pm
I'm assuming that you are using cash basis accounting, not accrual accounting since you are a non-inventory business.
In that case, you record an expense when you write a check, not when it clears the bank. You record revenue when you receive a check, not when it clears the bank.
The interesting part is the complication for your sub-contractors. You will be writing a check to them at the end of the year, but they likely won't receive it until the new year. In that case you will send them a 1099 that says that you paid them in 2013, but on their own books, they do not have income until 2014.
To resolve that discrepancy, typically the sub-contractor would include the 1099 number on Schedule C of their 2013 return, but take a miscellaneous expense on Schedule C that cancels that 1099 income. They then carry over the income to their 2014 return. If they do not at least match or exceed the reported 1099 income on the top line of their Schedule C, they risk a flag from the IRS, so they both add it and then subtract it on the Schedule C.
In that case, you record an expense when you write a check, not when it clears the bank. You record revenue when you receive a check, not when it clears the bank.
The interesting part is the complication for your sub-contractors. You will be writing a check to them at the end of the year, but they likely won't receive it until the new year. In that case you will send them a 1099 that says that you paid them in 2013, but on their own books, they do not have income until 2014.
To resolve that discrepancy, typically the sub-contractor would include the 1099 number on Schedule C of their 2013 return, but take a miscellaneous expense on Schedule C that cancels that 1099 income. They then carry over the income to their 2014 return. If they do not at least match or exceed the reported 1099 income on the top line of their Schedule C, they risk a flag from the IRS, so they both add it and then subtract it on the Schedule C.
- Jack
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Re: Subcontractor labor, 1099 and tax deductions
by xanadu32 » Sat Dec 21, 2013 11:12 pm
Thanks Jack. Yes, my accounting in cash-basis.
Because I issued the check in 2013, I can claim the deduction in 2013,
right? So, my 1099 will match my contractor labor expense line? When
they present my check in 2014 and the amount gets deducted from my bank
account, do I change the date of the transaction to 12/31/2013 in my
Quickbooks - because I already included that in my 2013 tax returns?
That way, the expense doesn't show up in my 2014 returns also?
Thanks for the response.
Thanks for the response.
- xanadu32
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Re: Subcontractor labor, 1099 and tax deductions
by Jack » Sun Dec 22, 2013 12:05 am
If you wrote the check in 2013, the expense goes in 2013, regardless what Quickbooks says.
You should be able to configure Quickbooks to give you a correct cash basis report using the date that the check was written, assuming your Quickbook accounts are set up properly.
Are you reporting as an S-corp or as a sole proprietorship? If sole proprietorship you could ditch the complication and expense of Quickbooks and just use Quicken.
You should be able to configure Quickbooks to give you a correct cash basis report using the date that the check was written, assuming your Quickbook accounts are set up properly.
Are you reporting as an S-corp or as a sole proprietorship? If sole proprietorship you could ditch the complication and expense of Quickbooks and just use Quicken.
- Jack
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Re: Subcontractor labor, 1099 and tax deductions
by xanadu32 » Sun Dec 22, 2013 12:24 am
If you wrote the check in 2013, the expense goes in 2013, regardless what Quickbooks says.
--> "If you wrote the check in 2013, the expense goes in 2013" and can be deducted in 2013 tax returns? Thank you!
You should be able to configure Quickbooks to give you a correct cash basis report using the date that the check was written, assuming your Quickbook accounts are set up properly.
--> When I issue the check, I make the payment from my Bank account. I don't record it in my Quickbooks at that point. I record it in my Quickbooks when I reconcile bank and my Quickbooks. And, it shows up in my bank list of transactions after the check cleared the bank. (Bank of America unlike ING doesn't deduct the amount as soon as I make the payment. It waits until the check is presented but ING deducts the amount immediately). Now, does that explain the problem better? I think I should record it in Quickbooks as soon as I send the check and not wait for it to clear the bank. Then, everything will tally accurately probably.
Are you reporting as an S-corp or as a sole proprietorship? If sole proprietorship you could ditch the complication and expense of Quickbooks and just use Quicken.
--> Sole proprietorship for now but want to "graduate" to S-corp next year and make the company ready for Fed Govt contracting.
--> "If you wrote the check in 2013, the expense goes in 2013" and can be deducted in 2013 tax returns? Thank you!
You should be able to configure Quickbooks to give you a correct cash basis report using the date that the check was written, assuming your Quickbook accounts are set up properly.
--> When I issue the check, I make the payment from my Bank account. I don't record it in my Quickbooks at that point. I record it in my Quickbooks when I reconcile bank and my Quickbooks. And, it shows up in my bank list of transactions after the check cleared the bank. (Bank of America unlike ING doesn't deduct the amount as soon as I make the payment. It waits until the check is presented but ING deducts the amount immediately). Now, does that explain the problem better? I think I should record it in Quickbooks as soon as I send the check and not wait for it to clear the bank. Then, everything will tally accurately probably.
Are you reporting as an S-corp or as a sole proprietorship? If sole proprietorship you could ditch the complication and expense of Quickbooks and just use Quicken.
--> Sole proprietorship for now but want to "graduate" to S-corp next year and make the company ready for Fed Govt contracting.
- xanadu32
- Posts: 19
- Joined: 23 Jul 2012
Re: Subcontractor labor, 1099 and tax deductions
by Jack » Sun Dec 22, 2013 1:23 am xanadu32 wrote:--> When I issue the check, I make the payment from my Bank account. I don't record it in my Quickbooks at that point. I record it in my Quickbooks when I reconcile bank and my Quickbooks. And, it shows up in my bank list of transactions after the check cleared the bank. (Bank of America unlike ING doesn't deduct the amount as soon as I make the payment. It waits until the check is presented but ING deducts the amount immediately). Now, does that explain the problem better? I think I should record it in Quickbooks as soon as I send the check and not wait for it to clear the bank. Then, everything will tally accurately probably
Absolutely, you should record the transaction when you issue the check. You later reconcile your records with the bank's records, but your issue date remains. You shouldn't rely on the bank to tell what checks you wrote. Instead you make your own entries and then cross-check them with what the bank says later.
- Jack
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Re: Subcontractor labor, 1099 and tax deductions
by xanadu32 » Sun Dec 22, 2013 1:54 am
Thanks. But it doesn't make logical sense,
right? (not questioning your comment - just trying to learn). Lets say, I
paid a contractor and he didn't cash the check - so the money is still
with me in my bank account but I get to deduct the amount in my tax
returns?
- xanadu32
- Posts: 19
- Joined: 23 Jul 2012
Re: Subcontractor labor, 1099 and tax deductions
by Jack » Sun Dec 22, 2013 3:35 am
When you write that check, you have incurred a
debt payable on your checking account. That debt is just at real as the
money sitting in your account. So when you write the check, the money
has been spent. Legally, the money is already gone. If you were to do a
net worth calculation immediately after writing the check, you would
subtract from your assets the amount due for that check. When that
money leaves your checking account is irrelevant. When the cash is
eventually removed from your account it simply cancels the debt you
already incurred. Your net worth doesn't change at that time.
Let's say you start out with $1000 in your checking account and this is your only asset. Your net worth is $1000.
Now you write a check for $100. You have $1000 in cash and a debt claim on your account of $100. Your net worth is $1000 minus $100, for a net of $900. You have spent $100.
Some time later, the check is cashed and the $100 taken from your account cancels the $100 debt on your account. You have $900 cash. Your net worth is the same as when you wrote the check. Your net worth didn't change when the check was cashed. Your net worth changed when your wrote the check.
It works the same way if you receive a check. If you get the check in your hands on December 31, it is income for 2013, even if you don't deposit the check until January 2014.
Let's say you start out with $1000 in your checking account and this is your only asset. Your net worth is $1000.
Now you write a check for $100. You have $1000 in cash and a debt claim on your account of $100. Your net worth is $1000 minus $100, for a net of $900. You have spent $100.
Some time later, the check is cashed and the $100 taken from your account cancels the $100 debt on your account. You have $900 cash. Your net worth is the same as when you wrote the check. Your net worth didn't change when the check was cashed. Your net worth changed when your wrote the check.
It works the same way if you receive a check. If you get the check in your hands on December 31, it is income for 2013, even if you don't deposit the check until January 2014.
- Jack
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Re: Subcontractor labor, 1099 and tax deductions
by xanadu32 » Sun Dec 22, 2013 11:37 am
Thanks Jack. Great explanation and thank you for
the patience. In your example, if the check for $100 was never cashed,
IRS still isn't at a disadvantage because - I included $100 in my 1099
to my contractor. So, even if I didn't pay the taxes on that $100 and
deducted that amount in my tax return, my contractor is expected to pay
the taxes on that amount. Am I understanding it correctly?
From accounting perspective, my bank balance and my accounting will be out of sync if the check isn't cashed. My accounting will show the debt but my bank wouldn't. Is this scenario common ? At what point, is the check considered "obsolete" and then, will $100 be added as an income?
And, when the check is cashed next year, is it common to adjust the date in Quickbooks to reflect the transaction "technically" happening in 2013 since it is already included in my 1099 for 2013?
Again, really appreciate you patiently responding and educating me.
-Xan
From accounting perspective, my bank balance and my accounting will be out of sync if the check isn't cashed. My accounting will show the debt but my bank wouldn't. Is this scenario common ? At what point, is the check considered "obsolete" and then, will $100 be added as an income?
And, when the check is cashed next year, is it common to adjust the date in Quickbooks to reflect the transaction "technically" happening in 2013 since it is already included in my 1099 for 2013?
Again, really appreciate you patiently responding and educating me.
-Xan
- xanadu32
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- Joined: 23 Jul 2012
Re: Subcontractor labor, 1099 and tax deductions
by bondsr4me » Sun Dec 22, 2013 12:31 pm
I use quick books Pro for my
accounting/tax/financial services business. There is the option when
you print your financial statements to print them on a "cash" basis.
The payments you make in 2013 are deducted in 2013 regardless of what
the subcontractor does. If the sub receives the check in 2013 but does
not cash until 2014 it is still 2013 income to him. He has
"constructive receipt" of the money even if he did not cash the check.
Hope this helps.
Don
Hope this helps.
Don
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Re: Subcontractor labor, 1099 and tax deductions
by BolderBoy » Sun Dec 22, 2013 12:52 pm
Others have given you the correct answer for a cash-basis entity paying vendors and providing 1099s.
I've been on the other end - a vendor out-of-town working from say Dec 20 - Jan 2, so I didn't actually see the checks until the next year, though the vendor 1099'd it for the previous year. So I tried an experiment one year in that the 1099 was for the year 2000 and I claimed the income in 2001, since I got home from the business trip on Jan 2 and deposited the check that day. Predictably, the IRS objected and I had to send along my explanation, yada yada. They accepted it all without issue, but it wasn't worth the hassle of the extra paperwork, so now I claim the income as the 1099 reports it.
For the same reason, I pay the 4th quarter estimated taxes on Dec 31 - so there is no misunderstanding that the estimated tax was actually paid in the year it was due and not the next year for the previous year (which always seemed a bit weird to me.)
I've been on the other end - a vendor out-of-town working from say Dec 20 - Jan 2, so I didn't actually see the checks until the next year, though the vendor 1099'd it for the previous year. So I tried an experiment one year in that the 1099 was for the year 2000 and I claimed the income in 2001, since I got home from the business trip on Jan 2 and deposited the check that day. Predictably, the IRS objected and I had to send along my explanation, yada yada. They accepted it all without issue, but it wasn't worth the hassle of the extra paperwork, so now I claim the income as the 1099 reports it.
For the same reason, I pay the 4th quarter estimated taxes on Dec 31 - so there is no misunderstanding that the estimated tax was actually paid in the year it was due and not the next year for the previous year (which always seemed a bit weird to me.)
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Re: Subcontractor labor, 1099 and tax deductions
by Jack » Sun Dec 22, 2013 1:23 pm BolderBoy wrote:I've been on the other end - a vendor out-of-town working from say Dec 20 - Jan 2, so I didn't actually see the checks until the next year, though the vendor 1099'd it for the previous year. So I tried an experiment one year in that the 1099 was for the year 2000 and I claimed the income in 2001, since I got home from the business trip on Jan 2 and deposited the check that day. Predictably, the IRS objected and I had to send along my explanation, yada yada. They accepted it all without issue, but it wasn't worth the hassle of the extra paperwork, so now I claim the income as the 1099 reports it.
One way to handle this, as I indicated in my first response above, is to add the 1099 number to your gross income on line 1 of your Schedule C, but then subtract the same amount as an expense on line 27 to cancel it out. You then carry over that income and report it the next year because that is when you actually received it. The IRS mainly is checking to see that line 1 is greater than the sum of all your 1099s. As long as you include it there, you should be okay. Line 27 requires an explanation which you can write "Income reported on 1099 in 2000 but received in 2001 and reported in 2001."
- Jack
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Re: Subcontractor labor, 1099 and tax deductions
by evelyn » Sun Dec 22, 2013 1:42 pm
I am a business owner, sole proprietor, with
several subcontractors. Based on what my accountant told me, any
payment I make to subcontractors in December 2013 is a 1099 deduction
for 2013, even if the subcontractor deposits the check in 2014.
Similarly, he has told me that if any of my clients send me a check dated 2013 (and include that amount in the 1099 they send me in 2014) even if I receive that check and deposit it in 2014, I have to claim that as income for 2013, not 2014, because that amount will be on the 1099 from the client. It's the same situation as the subcontractor who receives a payment from me dated 2013 but received in 2014. Can anyone confirm whether this is correct? Thank you!
Similarly, he has told me that if any of my clients send me a check dated 2013 (and include that amount in the 1099 they send me in 2014) even if I receive that check and deposit it in 2014, I have to claim that as income for 2013, not 2014, because that amount will be on the 1099 from the client. It's the same situation as the subcontractor who receives a payment from me dated 2013 but received in 2014. Can anyone confirm whether this is correct? Thank you!
- evelyn
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Re: Subcontractor labor, 1099 and tax deductions
by Jack » Sun Dec 22, 2013 2:34 pm evelyn wrote:I am a business owner, sole proprietor, with several subcontractors. Based on what my accountant told me, any payment I make to subcontractors in December 2013 is a 1099 deduction for 2013, even if the subcontractor deposits the check in 2014.
This is correct. The expense occurs when you write and mail the check. Not when it is cashed.
evelyn wrote:Similarly, he has told me that if any of my clients send me a check dated 2013 (and include that amount in the 1099 they send me in 2014) even if I receive that check and deposit it in 2014, I have to claim that as income for 2013, not 2014, because that amount will be on the 1099 from the client. It's the same situation as the subcontractor who receives a payment from me dated 2013 but received in 2014. Can anyone confirm whether this is correct? Thank you!
This is not correct, or rather half correct. You must include all 2013 1099s in your gross income for 2013 on line 1 of your Schedule C. But you do not include a check that you received in 2014 in your net income for 2013.
So you add the 2013 1099 to your gross income on line 1 of your Schedule C. This is what the IRS mainly checks, to make sure line 1 is equal or greater than the sum of all 1099s sent to you. Then on line 27 you subtract any checks that you actually received in 2014 but reported in a 1099 from 2013. Line 27 cancels out the 2014 checks on line 1. So your net income for 2013 does not include checks received in 2013. Next year you add that amount to your 2014 income.
The IRS uses a term called constructive receipt which means you book the income when you receive the check.
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