Fellow tax pro bloggers Jason Dinesen and Bruce McFarland have both posted on the subject of issuing a Form 1099-C to a deadbeat client - Jason in “Issue a 1099-C to a Deadbeat Client or Customer?” and Bruce in “Form 1099-C, Who Can Use It?”.
The issue arose when Bruce heard that other accountants use the Form 1099-C “(or the threat of this), to collect from clients who haven’t paid their fees”.
The reason for Bruce’s interest in the subject -
“I have a few CPA’s I have done work for, who have chosen not to pay their bill. Why couldn’t I instead of messing with collections, avoid the cost and time of collections, by just righting it off as a lesson learned and move on?”
Bruce called on Jason for advice on the legality of such a practice, who found that –
“In IRS SCA 1998-020, the IRS tackles this subject and seems to conclude that it’s acceptable for businesses to issue a 1099-C to a non-paying client, even though such reporting is not required.”
The bottom line of both posts is that, while there is nothing wrong with issuing a Form 1099-C to a deadbeat client, neither tax pro will do so. Jason believes – “you’d be causing more harm than good by issuing a 1099-C”.
I, too, have, in the past, thought about sending a Form 1099-C to former clients with long-overdue outstanding balances, and also decided against it.
First, and foremost, by issuing a Form 1099-C it means that I have cancelled the debt. I never cancel a debt arising from a tax return I have prepared. I did the job and I want the money.
Second, and also important, the 1099-C I would send for cancellation of an overdue tax preparation fee is not taxable income to the recipient.
According to IRS Publication 4681 (Canceled Debts, Foreclosures, Repossessions, and Abandonments) –
“If you use the cash method of accounting, you do not realize income from the cancellation of debt if the payment of the debt would have been a deductible expense.”
Tax preparation fees are deductible as a Miscellaneous Deduction on Schedule A, subject to the 2% of AGI exclusion. The fact that the deadbeat may not have been able to receive a tax benefit from the deduction because he/she does not itemize, or because of the 2% exclusion, does not matter. These fees, if paid, would have been a deductible expense, whether or not an actual tax benefit was received.
The example provided in the Pub goes directly to Bruce’s situation. It concerns cancelled accounting fees. The IRS says – “You do not include the cancelled debt in income because payment of the debt would have been deductible as a business expense”.
Even if the amount reported on the Form 1099-C would be taxable, it is actually cheaper for the deadbeat to pay the tax on the cancelled debt than pay me the balance due. Paying $25.00 or $28.00 to Sam is better than paying $100.00 to me – so why would the deadbeat pay me $100.00?
By the way - Joe Kristan also addresses this issue in his daily “Tax Roundup”.
So tax pros – don’t waste your time sending 1099-Cs to your deadbeat clients.