Passive Schedule C

Technical topics regarding tax preparation.
#1
WEISSEA  
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Client in new job gets teminated first month. Client wins settlement for botched termination. Payer sends 1099-MISC with clients share in box 14( should have been box 7). So I put 1099-MISC settlement income on Schedule C subject to SE tax. But is it a passive activity or non passive? That is do I apply the material participation tests to the settlement period, settlement period plus employment period, or is it automatically non passive because it is income subject to SE tax?
(motivation side note, if it were passive then the income would be offset by an LLC K-1 with a large rental passive loss).
Last edited by WEISSEA on 18-Apr-2019 4:28pm, edited 1 time in total.
 

#2
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Just because you put it on Schedule C doesn’t mean it’s an “activity” to which the passive rules would apply…
 

#3
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Jeff-Ohio wrote:Just because you put it on Schedule C doesn’t mean it’s an “activity” to which the passive rules would apply…


Are you saying you don't think this taxpayer is in the business of receiving settlements?
~Captcook
 

#4
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"Just because you put it on Schedule C doesn’t mean it’s an “activity” to which the passive rules would apply…"

Schedule C has a box called Material Participation yes, no. Pub 925: There are two kinds of passive activities. • Trade or business activities in which you don’t materially participate during the year. • Rental activities, even if you do materially participate in them, unless you’re a real estate professional
 

#5
Dennis2  
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"Botched termination" is not a particularly informative description. If wrongful termination i can see reporting as wages and fighting for employer liability for payroll tax or giving up and reporting as other income. Creating a supposedly operating business in which no one materially participates seems a bit of a stretch.
 

#6
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"If wrongful termination i can see reporting as wages and fighting for employer liability for payroll tax or giving up and reporting as other income."
1. Employer was supposed to withold FICA( indicating a settlement was compensation related) and failed to do so, instead issuing a1099-MISC I assume for the ex emplyee to pay. The client is not going to make an issue of the employer FICA 1/2 share.

"Creating a supposedly operating business in which no one materially participates seems a bit of a stretch".
2. The 1099-MISC forces the Schedule C and SE tax which appear to be correct. So you are saying a settlement that is compensation related is automatically a Non passive activity?
 

#7
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I think what others are saying is that if the nature of the activity is employment then the use of 1099-MisC to report compensation would not change the nature of the activity. To treat properly despite the 1099 issue you would consider that wages are always nonpassive, and that that wouldn’t change in the case of a 1099.
 

#8
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To treat properly despite the 1099 issue you would consider that wages are always nonpassive, and that that wouldn’t change in the case of a 1099.

Thanks to all, thats what I was looking for.
 

#9
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Schedule C has a box called Material Participation yes, no.

Yes. Schedule C has such a box…for a trade or business reported on Schedule C…which you don’t have.

Pub 925: There are two kinds of passive activities.

Right. And you don’t have a trade or business and you don’t have a rental activity.

Creating a supposedly operating business in which no one materially participates seems a bit of a stretch.

Oh, I think he’d have to argue that the attorney working the case put in more hours than the taxpayer. Othewise, arguendo, if the taxpayer did more work than any other individual, it wouldn’t be a passive activity as to the taxpayer. But that is just for argument’s sake, since we don’t have an activity here to begin with. If we did, the taxpayer should haul off and take big SEP and SE Health deductions…along with attorney fees (assuming they’re not already deductible above the line…but putting them on Sch C will save SE tax, of course).

Are you saying you don't think this taxpayer is in the business of receiving settlements?

Yes. The only cases I know of where trade or business status is accorded to something like this involves a qui tam claim. See the Bagley case. I think you’ll find that a case like that is way different than an employee who has a termination grievance and then gets the settlement reported on a 1099.

It's fine to report this thing on Schedule C, because taxpayers have to report their income. But doing so doesn’t mean you have an activity to which the passive rules would apply, like I originally said.

I’m working on a 1040 right now. A ton of investment interest expense will go unused. Therefore, I’ll report the guy’s wages on Schedule B to free up some of that interest expense…if I report the wages as interest income, doesn’t that mean it’s investment income?
 

#10
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What is the nature of the amount shown on Form 1099-MISC? If it’s a settlement that represents wages, then it should be reported as wages on line 1, Form 1040, not on Sch. C. If it’s a settlement for wrongful termination that’s not wages, then it should be reported as “other income” on line 21 of Sch. 1, not on Sch. C. If it’s payment for the taxpayer’s attorney’s fees, then it should be reported as “other income” on line 21 of Sch. 1, not on Sch. C. In any case, it doesn’t get reported on Sch. C.
 

#11
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"What is the nature of the amount shown on Form 1099-MISC. If it’s payment for the taxpayer’s attorney’s fees, then it should be reported as “other income” on line 21 of Sch. 1, not on Sch. C."

The client indicated the former employer was supposed to withold FICA but did not. That would indicate a settlement for wages. The employer issued a 1099-MISC box 14 ( attorneys fees) with the clients only share of the settlement (should have issued a W-2 or 1099-MISC box 7). Certainly the settlement is taxable subject to payroll tax. Proseries only allows one to allocate a box 14 amount to a Schedule C. Hence my question on passive or non passive.
 

#12
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WEISSEA, you seem to be elevating the decisions of your software over correct reporting. If that’s the case, and if the amount should really be reported as wages, then report the amount on Sch. C, then back it out with some sort of explanation such as “reported as wages” and report it, instead, on line 1, Form 1040. Then report the employee’s share of FICA and Medicare taxes on Form 8919.
 

#13
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"WEISSEA, you seem to be elevating the decisions of your software over correct reporting."

The error was the payors(former employer) by not issuing the correct information form. Note the payor errored also by not reporting the full settlement on the 1099-MISC requiring my client to deduct attorneys fees no longer allowed as a 2% itmeized deduction(see below).

At A’s request, P issues two checks that are delivered to A. One is payable solely to A for $100,000, representing compensation for legal services. The other check is payable solely to C in the amount of $200,000. P will report only the $100,000 on Form 1099-MISC (in Box 7) as paid to A. A only needs to record this amount on the frm records and tax returns. P will also fle a Form 1099-MISC reporting $300,000 as paid to C. (Current law requires the claimant to report the entire amount of the settlement payment – $300,000 in this case – as income, and then deduct the attorney fees as an itemized deduction, to the extent allowable.)
 

#14
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WEISSEA, I agree with everything you said. But just because the former employer erred by not reporting the wage portion of the settlement on a W-2, and by not withholding FICA or Medicare taxes, doesn't mean that you should perpetuate the error on the client's 1040.
 

#15
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dave829, thanks for your comments, I agree in theory, but I am only speculating on what information forms should have been issued. The employer has attorneys, accountants, and payroll people with detailed knowledge of the settlement. The Payor is presumed to be correct. Since the government is getting all required taxes via taxable income on Schedule C & SE rather than a W-2 and 941 the end result is the same.
 

#16
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If the income should have been on a W-2, the logical solution is Form 8919
Because on T.A. ten was the most you were allowed
 

#17
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The employer has attorneys, accountants, and payroll people with detailed knowledge of the settlement. The Payor is presumed to be correct.

You mention the $300k 1099 to your client. What 1099 box was this amount shown in?

Regardless, are you really subjecting this thing (i.e. the gross settlement) to SE tax?

If things were reported properly, even though I’m not yet convinced, it still sounds like you’re not listening…and you’re still hauling off and creating an incorrect construct. If it turns out nothing should have hit a W2 (which seems to be your position), then reporting this as fully subject to SE tax is way wrong. You are making the government more than whole…on your client’s dime. If it turns out some or all of it should have hit a W2, it’s not your job to have your client pay up for the employer’s mistake.

Your thought process has not been sound here. You ask about passive activity vs. non-passive, because you’re using Schedule C. That’s not even a legitimate question. Now we have the SE issue, which isn’t being handled right.

All in all, I disagree with your entire thought process here. I agree with Dave.

And I’m curious if any of the legal fees would be an above the line deduction.
 

#18
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"Your thought process has not been sound here. You ask about passive activity vs. non-passive, because you’re using Schedule C"

As I said in post #1, "or is it automatically non passive because it is income subject to SE tax"? I always thought it was non passive as the settlement arose out of the trade or business of being an employee. I was just looking for confirmation, as there is a large amount of money involved, and which post #7 was kind enough to do.
 

#19
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As I said in post #1, "or is it automatically non passive because it is income subject to SE tax"?

which post #7 was kind enough to do.

I understand what you said. And post #7 just re-iterated what had already been said in #2, #3 and #5. It’s not passive just because it was subject to SE Tax. It’s not passive because you don’t have an activity (despite throwing the income on Schedule C, therefore purporting to have a business activity, and then pointing to the Mat Par question on that Schedule). And if you don’t have an activity, you can’t have a passive one. The SE tax is an unrelated issue. Passive/non-passive determination isn’t based on something being, or not being, subject to SE Tax. Two completely different Code Sections with no linkage. Hence us having a real problem with the “because” part of your question.

I always thought it was non passive as the settlement arose out of the trade or business of being an employee.

If that’s what you thought, then why are you subjecting it to SE Tax?
 

#20
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We are basically dealing with interpretations of Regs. §1.6041-1(i) and (f)).

If terminator is paying lawyer directly should that amount be separately stated or included in gross?

Clearly if plaintiff is paying attorney he sends he sends 1099 with amount paid in box 14. Software, assuming recipient is an attorney, "forces" Schedule C.

Reporting when terminator is paying plaintiff and plaintiff's attorney separately is unfortunately not so clear. It has to be preparer's responsibility to report what actually happened. If a Box 14 amount is included in another 1099 it is essentially information, not income.
 

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