HOW THE IRS FINDS OUT ABOUT YOU.
The IRS, (and California to a lesser extent) has an extensive system of reporting requirements of business (and non-business) transactions. Most businesses, and some private individuals, are obligated to report certain transactions to the IRS and the Franchise Tax Board (California), with copies to the taxpayer. These reports are called "information returns". The IRS inputs this information into its computers and compares it to the income tax returns of individuals or businesses, which are also inputted into its computers.
If the transactions have not been reported by the taxpayer the IRS computer will automatically send a notice of tax due with a sweet message "inviting" the taxpayer to pay within 10 days ... or else!
Each one of these information returns has its own requirements. Generally, what you need to report is: name, taxpayer identification number, address, type of payment, and amount of payment. These reports are yearly, with the year running from January through December. The returns are due on January 31 for the payee, and the last day of February for the government.
Failure to comply with these requirements carries a penalty.
The following is a list and description of the most common returns required, but they are not all. Description of all the information returns would require a small book.
[1] Wages.
All payments that qualify as wages are reported on a quarterly basis with form 941 (or 942) to the IRS and Form DE-3 to California. There is an annual report, Form 940, to the IRS. These are payroll tax returns and will require an accounting of taxes withheld and taxes remitted. By January 31 of the following year you must file Form W-2, reporting the salary and deductions made to each employee. These are information returns.
The payroll tax returns and the W-2 information returns must match, or you will be asking for an audit.
The government then matches the W-2 amounts reported by the taxpayer (with Form 1040), with the amounts reported by the business.
[2] Services, interest, rents.
Persons engaged in a trade or business must report payments made to other persons, if during a calendar year the payments aggregate $600 or more. For example, if you make three payments to your accountant of $200 each, or you sublease from a person and pay him $700, you must report them. Amounts paid for material are included, so if a carpenter charges $400 for his services and $250 for material you must report that as a lump sum. The information return is IRS Form 1099. Payments to a corporation are exempt, but payments to a partnership must be reported.
[3] Dividends.
If you are incorporated and paid your shareholders $10 or more in dividends, you must report it.
[4] Real Estate transactions.
Every real estate transaction, including tax deferred exchanges, must be reported. The report must be made by one of these entities in the following order:
- The person responsible for closing the transaction
- The mortgage lender
- The seller's broker
or
- The buyer's broker
[5] Sales of inventory.
If you sell an aggregate of $5,000 or more of consumer goods to a buyer who sells such products in a home or some place other than a retail establishment you must report those sales. Why is this? The IRS wants to get to persons who sell out of swapmeets or trucks, streets, and home "parties" (read Amway).
[6] Interest.
Payment of $10 or more by banks, or by corporations on their bonds, to entities not incorporated, must be reported.
[7] Cash receipts of more than $10,000.
Any person who is engaged in a trade or business must report "cash" receipts of more than $10,000, even if that "cash" is received for the account of another. "Cash" includes foreign currency, cashier's checks, bank drafts, traveler's checks, and money orders, if each is for $10,000 or less.
Multiple payments. If the amount is received in partial payments, but it relates to the same transaction, it is viewed as a single payment for reporting purposes.
Example: You sell a car, the total price is $12,000. The buyer gives you $7,000 cash, and returns later with a cashier check of $5,000. The transaction is reportable.
Intentional failure to report such transaction has a penalty of $25,000 or the amount received, whichever is greater, but not to exceed $100,000, for each transaction.
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