BROKERS ARE REQUIRED TO FILE INFORMATION TAX RETURNS FOR COMMISSIONS PAID TO BROKERS AND AGENTSDecember 21, 2005Taxation Committee
Legislative CommitteeThe following is for study only and has NOT been approved by the Taxation Committee, Legislative Committee, the Executive Committees or the Board of Directors.Issue:
Should C.A.R. sponsor legislation that will provide a “safe harbor” for escrow companies that complete and file information returns (1099-MISC) on the behalf of brokers?Action:
Required.Options:
1.  Do nothing.
2.  Investigate the matter further.
3.  Sponsor legislation.
4.  Other.Status/Summary:
Brokers are responsible forfiling 1099-MISC forms with the Internal Revenue Service and the Franchise Tax Board for commissions of $600 or more paid to brokers and agents.  While brokers are required to file the information returns, they do not have to complete the 1099-MISCform themselves – they are only required to see to it that the form is completed and filed.  Directions can be included in the escrow instructions to have the escrow company complete and file the 1099 forms.  However, concerns have been voiced by representatives of the escrow industry about the liability that may accrue to an escrow company for any errors or mistakes that may occur for having followed the directions to complete the 1099 forms in the escrow instructions “to the letter.”  These representatives requested that a statutory “safe harbor” be established which would protect escrow companies from any liability for having explicitly followed the escrow instructions.DiscussionIn September, the Franchise Tax Board (FTB) released a brochure, “1099 Reporting for Real Estate Brokers.”  The release of the brochure has caused some distress among brokers that were unaware of their responsibility to file information returns with the Internal Revenue Service (IRS) and the FTB for commission payments to brokers and agents.  The requirement that brokers file information returns is long-standing and the brochure is merely an attempt on the part of the FTB to educate brokers as to the existing reporting requirements.  C.A.R. staff contacted the National Association of Realtors about this matter and was provided with documents dating from the early 1990s relating to the position of the IRS that a 1099 form must be filed by a broker in connection with commissions paid by that broker.It appears that the FTB is publicizing the 1099 reporting requirement now because there appears no end in sight to the budget deficits faced by the state.  And, given the sentiment of politicians and the public against raising taxes, it is likely that the budget deficits will continue.  However, given that real estate brokers and agents are not shirking their duty to pay income taxes on commissions earned, the FTB’s 1099 publicity campaign essentially amounts to “checking the sofa cushions for spare change” to increase revenues to the state.In the same manner that employee compensation is reported on the W-2 form, compensation to non-employees is reported on the 1099-MISC form.  Only payments made in the course of a trade or business must be reported.  This includes amounts paid to, for example, contractors, suppliers, and service providers.  When a commission payment of $600 or more is made to a broker or agent, the listing broker must file the 1099-MISC form with the IRS and FTB with a copy to the payee of the commission.  However, brokers can request permission from the IRS to participate in the Combined Federal/State Filing Program.  By participating in thisprogram, the broker reports only to the IRS which, in turn, forwards the pertinent information to the FTB.  This, thus, eliminates the need for the broker to report separately to the FTB.Generally speaking, payments to corporations do not have to bereported.  Exceptions include, for example, payments made to corporations for medical and health care or for attorney’s fees.  Consequently, given that the majority of real estate brokers are incorporated, listing brokers will have to report the commission payment to the buyer’s brokers in only a small percentage of all real estate transactions.According to the FTB, the listing broker must file a 1099-MISC for commission payments made to the buying or co-operating broker.  In addition, the listing broker must file an information return for the commission payment made to the listing broker’s agent.  The co-operating or buyer’s broker is responsible for reporting the commission payment made to the buyer’s agent.  In both of the latter situations, the broker would not have to file a 1099 for the commission paid to their agent if the agent is separately incorporated.Information returns must be provided to the recipient of the payment by January 31 following the current tax year.  Reporting to the IRS and FTB must occur by February 28 following the year of payment.  However, if the information return is filed electronically, brokers have until March 31 to file the return with the IRS and FTB.Thatthe broker is responsible for reporting commission payments does not mean that the broker must prepare the information return themselves.  Brokers are only required to see to it that the form is completed and filed.  Thus, they may delegate this ministerial function.  C.A.R. staff inquired with representatives of the escrow industry about having the escrow company that is handling the real estate transaction also produce the necessary completed 1099 forms.  These representatives did not see any difficulty with also producing the completed 1099 forms.  All that would be needed is to include the necessary directions in the escrow instructions.The only concern voiced by representatives of the escrow industry was with regard to the need for a “safe harbor” which would protect escrow companies from any liability for having followed the escrow instructions.  In other words, at the point that the escrow companies are filing information returns with state and federal taxagencies, they do not want to be held responsible for any mistakes or errors resulting from having followed the directions contained in the escrow instructions.  Errors made by the escrow provider, however, would remain their responsibility.  In addition, the representatives also requested authorization to charge – up to a capped amount – for the service of handling the 1099 forms to avoid allegations from consumer interests that they are adding “junk” fees to real estate transactions.