Independent Contractor Compliance Blog - by Collabrus™

Just when you think you’ve heard it all-the IRS recently issued a public notice that using FORM 1099-OID can constitute a “Frivolous Tax Argument” punishable by jail time and big fines.

Washington DC-The IRS recently issued its 2010 list of “Frivolous Tax Arguments” that it doesn’t want to hear from any of us. One of the highlighted arguments on the list is a Form 1099-OID being used as a debt payment option as a financial instrument drawing funds against the U.S. Treasury…

I normally don’t write about subjects like frivolous tax arguments, and their consequences, but this one was so unusual I thought, why not?

Some background

The purpose of Form 1099-OID (Original Issue Discount) is not for independent contractors. It is to report the original issue discount of holders of OID obligations, like certificates of deposit, time deposits, bonds, debentures, bonus saving plans, and Treasury inflation-indexed securities, that have a term of more than one year. OID is the excess of the stated redemption of the deposit, bond, or other financial obligation at maturity over its issue price.

OID is taxable as interest and must be included in the holder’s gross income.

Apparently someone has attempted to use the Form 1099-OID as a financial instrument to pay off tax, or other, debts…

The IRS warns that, “…Form 1099-OID is in no way a financial instrument (IC or not). It is not a legitimate method of payment of any public or private debt, and it is not a means to withdraw or redeem money from the Treasury(!)…”

The IRS reports that proponents of this theory argue they have sold or transferred their debt to the person to whom they issued the Form 1099-OID in a transaction (How can you sell a debt?).  The issuer of the Form 1099-OID then treats the face amount of the Form 1099-OID as “other income” on the individual’s return. The “other income” amount, however, is not included in the taxable income line.

IRS states, “Persons asserting this theory often significantly overstate withholding and claim an excessive refund in an amount close or identical to the inflated withholding.”

There are huge penalties, including possible jail time for frivolous tax arguments of any type.

Fines range from $5000 per incident (under The Tax Relief Health Care Act of 2006, which amended section 6702, IRC); to seventy-five percent of the underpayment (if civil fraud penalty under section 6663 IRC is applied) leading to many hundreds-of-thousands of dollars in fines.

If the IRS decides someone was attempting to evade or defeat tax under section 7201, a felony, they may assess a penalty or fine of up to $250,000 and imprisonment for up to 5 years for each violation.

Noteworthy is these penalties, fines and jail times apply to all frivolous tax arguments, not just this one.

Whether you’re dealing with investments or independent contractors it really doesn’t pay to be creative in this way. The IRS is not prone to rewarding creativity when it comes to tax payments and reporting.

Just utilize a true expert and be safe.