The Gulf Oil Spill: Tax Related Questions and Answers

Over the next few weeks, I will answer some of the most pertinent tax questions related to the Gulf Oil Spill.

Question one: Is a taxpayer required to include in gross income payments the taxpayer receives for lost business income, lost wages, or lost profits? 

Answer one: Yes. The law requires that a taxpayer include in gross income payments the taxpayer receives for lost business income, lost wages, or lost profits. A self-employed individual who receives a payment that represents compensation for lost income of the individual's trade or business should include the amount of the payment in net earnings from self-employment for purposes of the self-employment tax. 

Generally, a payment to an individual to compensate for lost wages will not be wages for purposes of the social security tax and Medicare tax because it is not an actual payment for employment within the meaning of the law. These payments will also generally not be subject to income tax withholding, unless backup withholding applies. See A-2, below, for a discussion of backup withholding. However, if the payment is made by an employer to its own employees, or by a third party to employees of another employer in satisfaction of an obligation of that employer to its employees, the payment may be subject to social security tax, Medicare tax, and income tax withholding. 

Question two: Are payments that are made to an individual for lost business income, lost wages, or lost profits required to be reported to the IRS by the person making the payment? 

Answer two: Generally yes. A person making payments to an individual for lost business income, lost wages, or lost profits must report the payments to the IRS on a Form 1099-MISC, Miscellaneous Income, if the payments aggregate $600 or more. Generally, these payments are subject to backup withholding at a rate of 28 percent if the individual fails to furnish the individual's taxpayer identification number to the payor at or before the time of payment. A payment that is treated as a payment of wages is subject to reporting on Form W-2, Wage and Tax Statement, and to the same social security tax, Medicare tax, and income tax withholding rules that apply to regular wage payments made by an employer to an employee.  Under current law, a person making payments to a corporation for lost business income or lost profits is not required to report those payments to the IRS. However, a person who makes payments to a Partnership, Limited Liability Company or other non-corporate entity for lost business income or lost profits generally is required to report those payments to the IRS in the same manner as for payments to individuals, and the payments are subject to backup withholding at a rate of 28 percent if the entity fails to furnish its employer identification number to the payor at or before the time of payment.

Keith L. Jones is a CPA and has an office in Port Saint Joe