Tax Compliance

Why Your Service Business Client Shouldn’t Have Cost of Goods Sold on Their Tax Return

Earmark Team · February 28, 2026 ·

You’re reviewing a new client’s prior-year returns when something catches your eye. The business is a consulting firm—pure services, no inventory to speak of—yet there’s cost of goods sold on Schedule C. You pull up the financial statements and find “cost of services” listed separately from other expenses. The previous preparer apparently decided consistency was the goal and carried the figure straight over to the tax return.

It’s a mistake Jeremy Wells sees all the time. In fact, he’s seen so many tax returns with this exact error that he devoted an entire episode of Tax in Action to breaking down what cost of goods sold really means for tax purposes and why getting it wrong matters more than you might think.

“I’ve seen a lot of tax returns prepared for new clients coming into my firm, where the returns were either self-prepared or prepared by another firm that reported cost of goods sold for a particular business when I knew that that business should not have reported cost of goods sold,” Jeremy explains.

You might think it all reduces taxable income anyway, so what difference does it make where the numbers land? But that reasoning misses something fundamental about what cost of goods sold actually represents in the tax code.

Only Three Types of Businesses Get Cost of Goods Sold

Treasury Regulation 1.61-3(a) tells us that only three types of businesses calculate gross income using cost of goods sold:

Manufacturing: businesses that produce goods from raw materials
Merchandising: businesses that purchase finished goods for resale
Mining: businesses that extract natural resources

If your client isn’t in one of these three categories, they don’t have cost of goods sold for tax purposes.

“No other kind of business has that formula described in terms of gross income,” Jeremy emphasizes. “Only businesses in those three categories: manufacturing, merchandising, and mining.”

This trips up practitioners because every business has what Jeremy calls “direct costs”—the expenses they must pay to generate revenue. He uses his own firm as an example. They use ProConnect tax software with a pay-per-return model, buying individual credits to file or print each client’s return. These are clearly direct costs related to serving specific clients.

But those software credits are ordinary business expenses, not cost of goods sold. Jeremy’s firm provides services, not merchandise. They don’t manufacture anything. They’re not mining. So despite having clear, traceable direct costs for each client, they don’t report cost of goods sold on their tax return.

The confusion gets worse with modern businesses that blur traditional categories. A business coach might sell one-on-one coaching (a service) while also selling digital products or online courses (potentially merchandise). A content creator might offer consulting while also selling physical products. Each revenue stream needs its own analysis.

“I’ve even had some pushback from new clients when we prepare that first tax return, where the prior returns had cost of goods sold reported, the return I prepared doesn’t, and the taxpayer actually notices and questions that,” Jeremy says.

Understanding which businesses qualify is just the start. The real insight comes from understanding why this classification matters so much.

Cost of Goods Sold Isn’t a Deduction—It’s Income Itself

Every tax professional knows the phrase, “expenses are deductible due to ‘legislative grace.’” Congress decides what deductions you can take. They can expand them, limit them, or take them away entirely.

But cost of goods sold works differently.

IRC Section 61 defines gross income as “income from whatever source derived.” For those three special categories of businesses, the regulations specify that gross income equals gross receipts minus cost of goods sold. This happens before you even think about Section 162 ordinary and necessary business expenses.

“Cost of goods sold is actually part of the definition of gross income when it comes to tax,” Jeremy explains. “It’s not just a special kind of expense.”

The courts have interpreted this to mean that cost of goods sold represents a “return of capital” rather than a tax deduction. When a store buys inventory for $50 and sells it for $100, that first $50 isn’t income; it’s just getting back the money they invested. The income is only the $50 profit.

This has real implications for what costs belong in the calculation. The basic formula is:

Beginning inventory + purchases of inventory + production costs (direct labor, freight)

– ending inventory

= cost of goods sold

Selling, general, and administrative expenses never belong in cost of goods sold, no matter how essential they are to running the business. These are always ordinary expenses.

The courts don’t care what you call things. In Atkinson v. Commissioner, a taxpayer tried to classify operating expenses as cost of goods sold. The Tax Court rejected this because the costs weren’t directly tied to inventory. As Jeremy notes, “Economic reality controls over labels used on tax returns or financial statements.”

For most businesses, this distinction is about accuracy. But there’s one area where understanding the difference between cost of goods sold and deductions becomes absolutely critical.

When Getting It Wrong Can Cost Millions: The Cannabis Example

IRC Section 280E is tough on cannabis businesses as it allows no deductions or credits for businesses trafficking in Schedule I or II controlled substances. Since marijuana remains Schedule I under federal law, dispensaries can’t deduct rent, utilities, salaries (except those directly tied to inventory), or any other ordinary business expense.

Their taxable income essentially equals their gross income. Except for cost of goods sold.

“Section 280E doesn’t disallow cost of goods sold,” Jeremy explains. “Because cost of goods sold is not an ordinary deduction; it is a reduction of gross income.”

This distinction became the center of Californians Helping to Alleviate Medical Problems (CHAMP) v. Commissioner, a 2007 Tax Court case that Jeremy calls “a really good illustration of why this concept is important.”

CHAMP operated both a medical marijuana dispensary and provided caregiving services for patients. Same business, two revenue streams, completely different tax treatment.

The IRS looked at the business and said it was trafficking in marijuana, Section 280E applies, no deductions allowed. CHAMP argued that costs of acquiring marijuana inventory were cost of goods sold that reduced gross income.

The Tax Court partially agreed. They allowed cost of goods sold, but only for costs directly tied to acquiring marijuana inventory. The dispensary’s operating costs were disallowed under 280E. It also disallowed the caregiving service costs and since caregiving is a service, those costs couldn’t be cost of goods sold anyway.

“The Tax Court allowed cost of goods sold, but only for the inventory-producing activity, only for the merchandising part of the business,” Jeremy clarifies. “Not for the caregiving services.”

This case shows having inventory isn’t enough to sweep all your costs into cost of goods sold. When a business has multiple activities, you have to analyze each one separately. And courts always look at economic substance over whatever labels you use.

Common Mistakes and How to Fix Them

Jeremy shares a frustration many practitioners face: clients who report the same inventory year after year or give suspiciously round numbers.

“We ask for their ending inventory and we get the same number as last year’s ending inventory, or we get round numbers,” he says. A restaurant claiming exactly $1,000 in beverage inventory while doing millions in revenue? “I seriously doubt that it’s an accurate reflection of their inventory.”

For sole proprietors and single-member LLCs, cost of goods sold goes on Schedule C, Part III. Corporations and S-corporations use Form 1125-A. Both forms walk through the same calculation: beginning inventory, plus purchases and production costs, minus ending inventory.

The key is educating clients about proper inventory counts and valuation. This matters for accuracy and for defending the numbers if the IRS asks questions. The substantiation requirements are the same as for any business expense. You must prove costs were incurred, properly classified, and correctly valued.

Jeremy also mentions that inventory valuation methods matter. Businesses can use First-In-First-Out (FIFO), Last-In-First-Out (LIFO), or average cost methods. But consistency is necessary. You can’t switch methods year to year just to get better results.

One final note on the future: if marijuana gets removed from Schedule I, Section 280E would no longer apply to cannabis businesses. But Jeremy cautions this would likely only affect future years. “It’s very unlikely that something like that would happen” retroactively, he explains. For now, the distinction between cost of goods sold and ordinary expenses is critical for every cannabis business.

The Bottom Line for Tax Professionals

If you take away nothing else from this episode, remember cost of goods sold belongs only to manufacturing, merchandising, and mining businesses. A consulting firm with “cost of services” is ordinary expenses. Same for the coaching business tracking direct costs.

“Just because the financial statements report cost of goods sold or cost of sales or cost of services doesn’t mean the tax return should or even can have cost of goods sold,” Jeremy emphasizes.

This isn’t about matching financial statements to tax returns. Cost of goods sold represents a return of capital invested in inventory, not just another expense category. When you get this right, you properly calculate income.

For most clients, fixing this means moving numbers from cost of goods sold to ordinary expenses. When they ask why their return looks different, you now have the framework to explain why accuracy matters more than consistency with an incorrect approach.

For cannabis clients, the stakes are much higher. Under Section 280E, properly identifying cost of goods sold might be the difference between staying in business and closing doors.

Whether you prepare returns for a local retailer or advise a multi-state dispensary, you should understand what cost of goods sold really means, know which businesses qualify, and report costs where they belong based on substance, not convenience.

To dive deeper into the regulations, court cases, and practical examples, listen to the full Tax in Action episode. Jeremy walks through each concept step by step, giving you the technical foundation to turn confusion into competency.

This $600,000 Lesson Proves You Can’t Outsource Your Filing Deadline

Earmark Team · February 17, 2026 ·

Wayne Lee, a Florida surgeon, hired CPA Kevin Walsh to prepare and file his tax returns. From 2014 through 2016, Wayne provided Kevin with all necessary documents and signed Form 8879 e-file authorizations each year. As far as Wayne knew, Kevin was doing exactly what he’d been hired to do: preparing and filing returns, each showing mid-six-figure tax liabilities but also substantial refunds due.

Wayne discovered the truth on December 5, 2018, when an IRS agent showed up at his office. Kevin had never filed any of those returns. He’d never told Wayne about a software issue that supposedly prevented e-filing. The IRS notices had piled up at an incorrect address that Kevin promised but failed to update. By the time Wayne discovered the problem, the three-year statute of limitations had expired on his $288,000 refund from 2014. Instead of rolling that refund forward as planned, Wayne ended up paying $289,000 to the IRS in 2019 to settle unpaid liabilities, penalties, and interest.

Wayne sued Kevin (settling out of court) and the federal government for a refund. The government won.

In a recent episode of Tax in Action, host Jeremy Wells, CPA, EA, uses Wayne’s case to explore a principle the Supreme Court established decades ago: you can delegate tax return preparation, but you can’t delegate responsibility for filing deadlines. Understanding this distinction and the penalties that follow when taxpayers miss deadlines is crucial for tax professionals and their clients.

How Failure to File and Failure to Pay Penalties Work

The penalties Wayne faced were calculated additions to tax that accrued interest and turned a potentially manageable balance into a serious financial burden.

The failure to file penalty under IRC Section 6651(a)(1) is the more severe of the two delinquency penalties. It’s 5% of the net amount due for each month or fraction of a month the return is late. That “fraction of a month” language carries real weight. File your return one day late, and you owe a full month’s penalty. The penalty maxes out at 25% of the net amount due, unless fraud is involved. In fraud cases, the penalty jumps to 15% per month with a 75% ceiling.

“The net amount due means the tax liability shown on the return less any withholding credits, estimated payments, or any other payments made on or before the due date,” Wells explains, emphasizing a critical point. This definition, from IRC Section 6651(b)(1), means even if you can’t file on time, making payments reduces the base amount for penalty calculations.

The failure to pay penalty under IRC Section 6651(a)(2) is gentler at 0.5% per month, but it comes with its own trap. As Wells explains, “An extension of time to file is never an extension of time to pay.” Treasury Regulation 1.6081-4(c) makes this explicit. That six-month extension gives you time to finish the paperwork, not time to find the money.

When both penalties apply, as in the case of an unfiled return with an unpaid balance, they don’t stack. The failure to file penalty gets reduced by the failure to pay amount, keeping the combined rate at 5% per month. But both count as “additions to tax,” meaning interest accrues on the penalties themselves, compounding the total amount owed over time.

The math drives the strategy. As Wells puts it, “Why pay 5% when you only have to pay 0.5%?” Always file on time, even with a balance due. Always request extensions if you need more preparation time. And make estimated payments before April 15th to reduce the net amount due that serves as the penalty base.

Partnerships and S Corporations Face Different Rules

Pass-through entities don’t pay income tax directly, so there’s no failure to pay penalty. But their failure to file penalties can be devastating.

Under IRC Sections 6698 (partnerships) and 6699 (S corporations), the penalty is an inflation-indexed amount per partner or shareholder, per month the return is late. For 2025, that’s $245 per partner or shareholder, increasing to $255 in 2026 and $260 in 2027.

Wells stresses the multiplication effect. “By definition, a partnership has at least two partners. So if you have a late 1065, then at a minimum, the penalty will be doubled.” A small partnership with four partners and a three-month late filing would owe nearly $3,000 in penalties for 2025.

The penalty amount is determined by the year the return should be filed, not the tax year of the return. So if you file a 2024 partnership return late in 2025, you use the 2025 penalty amount.

Relying on Your Tax Professional Won’t Save You

Wayne’s defense seemed reasonable. He hired a licensed CPA, signed e-file authorizations, provided all documents, and was repeatedly assured his returns were being handled. Surely that demonstrates ordinary business care?

The courts said no, following precedent from United States v. Boyle (1985). In that case, the Supreme Court reversed an appeals court that sided with a taxpayer whose attorney missed an estate tax filing deadline. The Supreme Court held that taxpayers cannot delegate filing and payment deadlines to professionals.

When Wayne’s case reached the 11th Circuit in 2023, his attorneys argued that e-filing changes this dynamic. If only the professional can electronically submit returns, doesn’t that shift responsibility? The court rejected this argument entirely. “E-filing does not change the taxpayer’s duty,” they ruled.

So what actually qualifies as reasonable cause? The IRS outlines acceptable categories in Internal Revenue Manual 20.1.1.3.2:

Death or serious illness of the taxpayer, immediate family member, or key employee within an organization (not an outside professional)
Fire, casualty, or natural disaster directly causing non-compliance
Legitimate inability to obtain essential records after reasonable efforts (poor recordkeeping doesn’t count)
Reliance on erroneous written IRS advice specifically addressing your situation
Ignorance of the law, but only if you had no prior filing requirement, tried to learn the law, and the issue was genuinely complex

Wells notes a crucial limitation: if you’re “demonstrably competent enough to carry on other transactions,” like hiring and working with a tax professional, “reasonable cause won’t work.”

The message is clear: tax professionals can prepare returns and provide advice, but the legal duty to ensure filing and payment remains with the taxpayer.

First-Time Abatement Is Your Best Shot at Relief

While reasonable cause rarely succeeds, taxpayers have another option that’s often more accessible: First-Time Abatement (FTA).

The IRS evaluates penalty relief requests in a specific order, outlined in IRM Chapter 20:

Correction of IRS error
Statutory and regulatory exceptions
Administrative waivers (including FTA)
Reasonable cause

Notice that FTA comes before reasonable cause, even though reasonable cause is statutory. The National Taxpayer Advocate has criticized this ordering, but for taxpayers, it creates opportunity.

FTA covers failure to file, failure to pay, and failure to deposit penalties, but not the underpayment penalty. To qualify, you need:

Clean penalty history for three prior years (no unreversed penalties)
All required returns filed
Tax paid or payment arrangement in place

A critical change occurred in March 2023. “If you have a taxpayer with a relatively small penalty and you don’t ask for first time abatement, and then the following year they get an even bigger penalty, first time abatement is not available because it should have been used on that first penalty,” Wells explains.

The old strategy of “saving” FTA for a potentially larger future penalty no longer works. Use it when you’re eligible, or lose it.

Timing matters for requesting FTA. You can’t abate a penalty before it’s assessed, so wait for the notice—typically a CP14 or CP162. Get Form 8821 or 2848 authorization from clients and check the box to have notices forwarded to your office. When the notice arrives, respond immediately or call the Practitioner Priority Service for faster resolution.

Good news is coming: the National Taxpayer Advocate announced that starting with tax year 2025 returns, the IRS will begin automatically applying FTA to eligible penalties. Until then, it remains a manual process.

Protecting Yourself and Your Clients

“Penalty abatement is really less about proving innocence and more about understanding the timing, the procedures and how the IRS operates,” Wells says to summarize the episode’s overarching message.

For tax professionals, this means building clear communication into every client engagement. Clients must understand that while you prepare returns, they’re still responsible for confirming filing and payment. This isn’t about avoiding responsibility; it’s about accurately representing how tax law works.

Wayne Lee did everything a reasonable person would do, yet still lost nearly $600,000. His case is a reminder that in tax compliance, good intentions and professional help aren’t enough. The responsibility to file and pay on time ultimately rests with the taxpayer, and they can’t delegate that duty.

Listen to the full episode of Tax in Action for Jeremy’s’ complete analysis of IRC Section 6651, including detailed penalty calculations and step-by-step guidance for requesting abatement.

How to File 1099s Without the January Scramble

Earmark Team · February 2, 2026 ·

Alicia Katz Pollock, host of The Unofficial QuickBooks Accountants Podcast, just spent a week in what she calls “1099 Heaven,” teaching her comprehensive 1099 class and attending Nancy McClelland’s Ask a CPA workshop. She came away from that week ready to share a concentrated breakdown of everything accounting professionals need to know about 1099 filing.

“I’ve been watching the socials and people are asking, ‘Which report do I run so to filter out payments under $600 and payment processors?’ and, ‘How do I export to Excel?’” Alicia observes. “And the truth is, you don’t need to.”

QuickBooks Online has built-in tools that handle most of the filtering and analysis automatically. Yet every January, accounting forums light up with practitioners frantically exporting data to Excel, second-guessing payment methods, and chasing down W-9 forms as the deadline approaches.

In episode 125, Alicia breaks down what you actually need to know, including who qualifies for a 1099 (and why small errors won’t hurt you), which payment methods trigger reporting in our fintech-heavy world, and the QuickBooks tools that eliminate hours of manual work.

Understanding 1099 Compliance

Before diving into QuickBooks tricks and automation, you need to understand what these forms actually accomplish, and what’s changing in 2026.

Essentially, the 1099 system exists because the IRS wants to verify that contractors report their income. When you pay another business for services, you’re telling the IRS about that payment. They match your report against what the contractor claims on their taxes, making sure nobody’s working under the table.

“Literally millions of dollars, if not billions of dollars, is wasted in lost productivity while we chase down W-9 forms and file all these forms and do all of our research just to make sure that everybody is on the up and up,” Alicia says, not holding back her frustration. “So it’s kind of a vicious cycle.”

What’s New for 2026

This year brings a significant addition with Form 1099-DA for digital asset transactions. The IRS is finally tracking cryptocurrency sales and income, attempting to bring crypto economics into the traditional tax framework.

The $600 threshold that’s been in place for decades stays the same this year, but relief is coming. The One Big Beautiful Bill raises this to $2,000 starting in 2027. As Alicia notes, “The vast majority of my small businesses and micro businesses probably wouldn’t even qualify and won’t need to do this at all next year.”

Who Gets a 1099?

The rules are simpler than many make them:

Send 1099s to:

Self-employed individuals
LLCs filing as sole proprietors
Partnerships
Attorneys (even if incorporated)
Independent landlords (not property management companies)

Don’t send 1099s to:

S Corps
C Corps
Property management companies

Remember to check beyond your expense accounts. Balance sheet items like prepaid expenses, leasehold improvements, and due to/from accounts might contain qualifying payments. And if one company pays on behalf of another, the company that received the service files the 1099.

The Accuracy Question

Fear of making small mistakes keeps practitioners up at night unnecessarily.

“If your 1099 is off by $100 or $200, nobody’s going to come knocking on your door,” Alicia says reassuringly. “The IRS is short staffed. They’re really not looking for $600 in revenue. But if you’re talking hundreds of thousands of dollars, then it’s a bigger concern.”

The IRS primarily cares whether contractors report income lower than their total 1099s. If someone receives $200,000 in 1099s but reports $250,000 in income, no red flags appear. Problems only arise when reported income falls below documented payments.

Alicia shares a cautionary tale about a cleaning service client who paid cleaners as contractors for 15 years despite warnings. “Sure enough, she got audited after 15 years. And it turns out that the IRS agreed with me that they really are employees, so she now has some fines to pay.”

W-9 Best Practices

The key to avoiding January panic is to collect W-9s immediately when hiring someone. Don’t wait to see if they’ll hit the threshold; just send it. And don’t pay until you receive it back.

If contractors ignore your requests, you have leverage. Threaten to withhold 24% of their payment for backup withholding. “That warning is usually enough to get them to reply,” notes Alicia. If they still won’t cooperate, file the 1099 anyway with a blank EIN. “Unfortunately that might trigger an audit for them, but if they’re not sending you a W-9, well, what are they hiding?”

One persistent problem is W-9 forms often come back filled incorrectly, especially from LLCs. The form should show information for the entity actually paying taxes, not a pass-through or disregarded entity. Many people put their personal name on line one and business name on line two backwards, creating confusion about their tax status.

Navigating the Payment Method Maze

Much of the 1099 confusion stems from uncertainty about which payments count. With the explosion of fintech platforms, determining what triggers reporting has become increasingly complicated.

The Foundation Rule

You send 1099s for payments from your bank account, including:

Cash and checks
Online bill pay
ACH transfers
Wire transfers
Zelle

You don’t send them for credit or debit card payments. The merchant processors handle their own 1099-K forms.

The Fintech Gray Zone

PayPal, Venmo, and similar platforms create confusion. The determining factors are whether you use the business or personal version and whether you’re paying “friends and family” or for “goods and services.”

Alicia recommends asking two key questions:

Does it charge a transaction fee? If yes, you likely don’t need a 1099
Does it have its own bank balance? PayPal and Venmo do, so that’s another sign you’re off the hook.

Business versions of these platforms send their own 1099-K forms. However, merchant services use different thresholds: $20,000 and 200 transactions, maintained by the One Big Beautiful Bill. This creates a gap where payments between $600 and $20,000 via credit card aren’t reported by anyone, and that’s perfectly fine from a compliance standpoint.

For navigating the infinite fintech combinations, Alicia strongly recommends Jennifer Diamond’s 1099Problems website.

Material Reimbursements

How contractors invoice determines the treatment:

When materials are wrapped into the service invoice, you include everything.
When materials are itemized separately, you exclude materials and report services only.
When materials are invoiced separately, you ignore them entirely.

“The IRS knows you’re paying them the full price for the whole service, and it’s up to the contractor to do their own deductions for their own material costs,” Alicia explains.

The Reference Number Secret

Alicia shares a “hot tip” most practitioners don’t know. QuickBooks expense forms have a reference number field that automatically excludes transactions from 1099 processing.

“You would think the payment method would be the thing that allows you to do the exclusion, but no. It doesn’t work that way,” she notes. Instead, enter “debit,” “card,” “Visa,” “MC,” “Chase,” “Discover,” “PayPal,” or “Amex” in the ref number field. The wizard recognizes these and excludes the transactions—a feature carried over from QuickBooks Desktop.

Mastering QuickBooks Online’s 1099 Tools

Despite QBO’s built-in capabilities, Alicia observes practitioners still asking which report to run in order to filter out for the $600 and for the payment processors. The tools exist, but many don’t know where to find them.

The Contractors Center Hub

The Contractors Center, located under Expenses and Bills (and under Payroll, if enabled), manages 1099-eligible vendors from start to finish. Any vendor with “track 1099” checked appears here automatically.

The standout feature is self-onboarding. Invite vendors via email to complete a digital W-9 through their QuickBooks account or the free QuickBooks Money app. The system captures everything, including their name, address, tax ID, entity type, and qualification status.

“Tell them to look for it because it looks like spam,” Alicia warns. “It just says QuickBooks needs your W-9 and bank info and who is going to click that?”

Payment Processing Options

The Contractors Center offers multiple payment methods, including:

QBO Payroll subscribers: Contractors treated as employees at your per-employee rate
Contractor-specific plan: $10.50 monthly for up to 20 contractors, $1.70 each additional
QBO Bill Pay: Standard functionality

The 1099 Preparation Wizard

Access the wizard via “Prepare 1099” in the Contractors Center or the dedicated 1099 section under Expenses and Bills in the new navigation.

There are two approaches available: “Try Autofilled Forms,” which is an AI-powered automation, or “Prep My Own” for manual step-by-step control.

“I tried it this year and honestly they came up with the same information,” reports Alicia. Choose based on comfort level—automation for hands-off clients, manual for those wanting verification.

Custom Reports for Analysis

The wizard includes two reports: Accounts to Pay Vendors and Vendor Transactions. “I turn on the track 1099 status and then filter it so the status is on and the amount is greater than $600 instead of looking at the big list of all the payments for all the vendors,” Alicia says, explaining her workflow.

State Filing Complications

Some states participate in the Combined Federal and State Filing Program, and QBO handles both simultaneously. Others require separate filing through state websites.

Alicia’s particular frustration is that she’s located in Oregon. “it stinks for me because QuickBooks doesn’t export any kind of report that I can import into Oregon’s filing system. So I wind up having to type them all in by hand.”

Corrections After Filing

If you make an error, QBO allows corrections after IRS acceptance. Replace incorrect forms with $0, add forgotten contractors, or submit corrected amounts. Third-party platforms offer similar capabilities.

Your 1099 Action Plan

As Alicia emphasizes throughout the episode, the tools exist to make this process manageable. Stop exporting to Excel. Stop manually filtering. Use the automation that’s already there.

Looking ahead, the 2027 threshold increase to $2,000 will eliminate this requirement for many small businesses entirely. Until then, master these tools and workflows to transform 1099 season from a compliance nightmare into a streamlined process.

For an even deeper dive into 1099 filing, check out Alicia’s Payroll Perfection bundle, which includes QBO Payroll, QuickBooks Time, and payroll compliance training. And be sure to listen to the full episode for additional insights from Alicia’s week in “1099 Heaven.”

Alicia Katz Pollock’s Royalwise OWLS (On-Demand Web-based Learning Solutions) is the industry’s premier portal for top-notch QuickBooks Online training with CPE for accounting firms, bookkeepers, and small business owners. Visit Royalwise OWLS, where learning QBO is a HOOT!

From Data Entry Nightmare to Automated Workflow in One Demo Session

Earmark Team · February 2, 2026 ·

You’re ten days away from the 1099 and W-2 deadline, and you’re still wrestling with QuickBooks, fielding a flood of W-9 request emails, and dreading the inevitable data entry marathon. Sound familiar?

You’re not the only one. As David Leary admitted during a recent Earmark Expo webinar, “I’ve been procrastinating on issuing 1099s. It’s just not a great experience.” He described the dual frustration that many accountants know all too well. “It’s annoying work on both sides. I need to do my 1099s, but then, as a business that receives them, I get a slew of emails from other companies asking for a W-9.”

In the webinar, David and co-host Blake Oliver took TaxBandits for a test drive with Nikita Sullivent, the company’s Support Specialist, to explore how this IRS-authorized e-file platform handles over 70 tax forms. The live demo included the authentic technical hiccups we all face with real-world software and shared practical solutions for the compliance challenges that hit every January.

Getting your data in: from hours to minutes

Manual data entry for hundreds of 1099s is a bottleneck that keeps you from serving more clients. TaxBandits tackles this with multiple import options that meet you where your data lives.

The platform offers three main paths for getting data in. You can:

Enter forms manually one at a time (perfect for that forgotten contractor),
Use bulk upload templates for larger volumes, or
Connect directly with accounting software (current integrations include QuickBooks Online, Xero, Sage Intacct, and Zoho, with Karbon integration coming soon).

The bulk upload process stands out for its simplicity. As Nikita demonstrated, “You’re reviewing the columns at the top and inputting the data beneath them. Once we have all of that data input, we’ll just download it as a CSV and drag and drop it in.”

David particularly appreciated one detail. “I like how on your templates, in the header of each column, you give the instructions for the values you accept in that field.” No more guessing whether to use “CA” or “California,” or whether TINs need dashes.

The workflow breaks down like this:

Download the Excel template with clear column headers
Fill in your data following the built-in instructions for each field
Drag and drop the file into TaxBandits
Review the automatic error check that flags issues like missing digits in EINs or duplicate records
Fix any problems by either editing in the app or exporting just the error records for correction

For QuickBooks users wondering about the process, David confirmed you can export your vendor list, filter for 1099 vendors, and use the “upload your own file” feature. The first time requires mapping your fields to TaxBandits’ fields, but that mapping saves for future uploads.

One webinar attendee asked whether they needed to re-enter last year’s payees. “Absolutely not,” Nikita answered. “Everything stays in your account and rolls over year after year.” When you import this year’s data and the system finds a duplicate, you can either delete it or update the existing record with any changes.

The platform also distinguishes between importing only recipient data and importing both payer and recipient data. If you maintain TaxBandits throughout the year, importing just recipients during filing season works best since you’ve already set up your payers. But if you’re adding everything at once, the combined import saves steps.

With data flowing smoothly into the system, the next challenge is ensuring that data won’t bounce back from the IRS.

TIN verification: the new compliance reality

Getting data into the system efficiently matters only if it passes IRS validation. The agency’s transition from the FIRE system to IRIS (Information Returns Intake System) brings stricter requirements that every accountant needs to understand.

“The IRIS system is going to be far stricter on TIN matching than the FIRE system was,” Nikita warns. “Which means if the SSN, the EIN, the TIN, and the recipient name don’t identically match the IRS database, it’s going to kick the form back to you as accepted with errors, and you have to file a correction.”

The keyword is “identically.” A contractor who goes by “Mike” but whose Social Security card reads “Michael” could trigger a rejection. Even punctuation differences in business names can cause problems.

TaxBandits builds TIN verification into multiple touchpoints:

When collecting W-9s throughout the year
When adding recipients to your address book
During the 1099 workflow as a final check

The smart approach starts early. “When you get a W-9, when you get a new employee or contractor, you go ahead and do the TIN matching on that prior to the filing season,” Nikita advised. This prevents last-minute surprises when deadlines loom.

Verification typically returns within two to four hours during normal periods. But during peak season “it can be up to 24 hours,” Nikita warned. If you’re verifying TINs within the 1099 workflow itself, the system waits for results before transmitting, which is potentially problematic if you’re filing on January 31st.

For those worried about the cost of corrections, TaxBandits offers some protection. Their “TaxBandits Commitment” covers correction filings at no additional charge. But even free corrections cost you time and stress.

The platform also streamlines W-9 collection. Instead of chasing paperwork, you can send electronic W-9 requests. Recipients complete them online, and the data flows directly into your TaxBandits account, ready for immediate TIN verification if desired.

Once your forms are prepared and verified, you still need to get them into recipients’ hands compliantly.

Distribution flexibility that actually works

The old choice between hours at the post office or forcing everyone into electronic delivery is over. Modern distribution needs flexibility, and TaxBandits delivers exactly that.

“Everything is very customizable to your needs,” Nikita explained when asked about mixing delivery methods. “You can choose some postal mail, some online access, and some want both.”

The three distribution paths each serve different needs:

USPS postal mailing handled entirely by TaxBandits
Electronic recipient portal requiring just an email address
Both options for recipients who want backup

The electronic portal solves a critical compliance issue. The IRS requires formal consent for electronic delivery, so you can’t just email a PDF. TaxBandits automates this. Recipients receive a secure link, enter a PIN for verification, and provide documented consent.

If someone ignores that email, the system tracks everything. You can see who consented, who declined, and who never responded and then handle postal delivery for the holdouts.

For returning recipients, the portal builds value over time. “If you file for that same recipient next year, they’ll use the same link, and they’ll access all of the documents from the same portal,” Nikita noted. Recipients get their own organized tax document archive without any extra work from you.

State filing adds another compliance layer, but TaxBandits simplifies this, too. The platform tells you exactly what each state requires:

States requiring direct filing (you handle separately)
Combined Federal/State Filing participants (automatic forwarding)
States requiring no 1099 filing

Throughout the process, you get real-time status updates so you can see which forms were transmitted to, received by, and accepted by the agency. For postal mail, statuses are submitted to USPS and en route to the recipient. When a client claims they never received their form, you have documentation. After transmission, watermarks disappear from your copies, and you can reprint professional versions anytime.

For firms with multiple preparers, the platform offers even more control through team management features.

Scaling with teams and support

Larger firms need more than just bulk upload; they need workflow management. TaxBandits’ team management features let you maintain control while delegating the actual work.

The system offers three permission levels:

No roles: Any team member can prepare, approve, and transmit
Two roles: Preparers create forms, approvers review and transmit
Three roles: Preparers create, approvers review, transmitters handle payment and filing

You can also create location-based groups. Nikita shared an example. “Say you have a group in Indiana and a group in Tennessee. Anytime you add a new payer and assign them to the Tennessee group, then all of the team members included in the Tennessee group have access to that payer.”

Support is critical when things get complex. During busy season, TaxBandits extends hours to 8 a.m. to 8 p.m. Eastern. They offer phone, email, and chat support, plus an AI assistant that pulls from both their knowledge base and IRS guidelines.

The platform’s YouTube channel provides step-by-step videos for specific workflows. For Sage Intacct users who asked about integration, Nikita recommended checking their channel for detailed walkthroughs showing the complete process from Sage to TaxBandits.

Pricing works on a credits system with bulk discounts. Buy more credits upfront, pay less per form—and credits never expire. As Nikita confirmed when asked about rollover, “Your credits will never expire. So if you want to purchase for the next five years now and get the best price we can give you, go for it.”

Making next year easier starts now

The strategies demonstrated in this webinar show a fundamentally different approach to information returns. TaxBandits treats compliance as a year-round process rather than a January panic.

The IRS’s push toward e-filing mandates and stricter validation isn’t slowing down. The IRIS system is just the beginning of modernization efforts that will continue tightening requirements. But the webinar demonstrated real workflows you can adopt immediately, from template imports to electronic W-9 collection to role-based team permissions.

Ready to transform your 1099 and W-2 workflow? Watch the full Earmark Expo webinar to see TaxBandits in action, including the complete demo of bulk uploads, error checking, and team management features. The platform offers over 70 tax forms beyond just 1099s and W-2s, making it a comprehensive solution for year-round compliance needs.

Company Vehicles, Cell Phones, and Office Snacks: What’s Actually Tax-Free for Employees

Earmark Team · February 2, 2026 ·

Have you ever had to explain to a client that the $35 gift card they gave each employee for the holidays must be reported as taxable compensation, but the $35 holiday ham they gave last year was completely tax-free? Welcome to the world of fringe benefit taxation, where seemingly identical gestures of employee appreciation can produce dramatically different tax consequences.

This counterintuitive example comes from Episode 18 of the Tax in Action podcast, where host Jeremy Wells, EA, CPA, continues his deep dive into IRC Section 132’s fringe benefit provisions. Building on a previous episode discussing no-additional-cost services and qualified employee discounts, this episode covers two benefit categories that touch nearly every business with employees: working condition fringes and de minimis fringe benefits.

Many employers want to provide benefits to their workforce, but the line between tax-free perks and reportable compensation often comes down to surprisingly specific details. Understanding these distinctions helps tax professionals guide clients toward meaningful benefits without triggering unexpected tax consequences.

When structured correctly, these benefits are deductible for the employer and excludable from the employee’s taxable compensation. Get the details wrong, and what was intended as a thoughtful perk becomes reportable wages subject to income, employment, and state taxes.

Working Condition Fringes Help Employees Do Their Jobs Better

The concept behind working condition fringes is straightforward. If an expense would be deductible under IRC Section 162 (ordinary business expenses) or Section 167 (depreciation) had the employee paid for it personally, the employer can provide that benefit tax-free. Some common examples include company vehicles for service technicians, professional development courses, business travel, and other things employees genuinely need to perform their jobs effectively.

But practitioners need to pay close attention to ensure the benefit relates specifically to that employee’s role with that employer. As Wells explains, if the expense instead supports outside professional activities, such as consulting privately, serving on an external board, or running a separate venture, the employer’s payment doesn’t qualify as an excludable working condition fringe. The employer would essentially be subsidizing something that benefits the employee’s outside activities rather than their own business operations.

Who Counts as an “Employee” (And Who Doesn’t)

The definition of “employee” for working condition fringes is broader and narrower than you might expect. It includes current employees, partners performing services for a partnership, directors of the employer, and even independent contractors performing services for the employer. This expanded definition allows businesses to provide qualifying benefits across different working relationships without triggering taxable compensation.

However, the definition is more restrictive than what applies to other fringe benefit categories. Former employees, spouses, and dependents can qualify for no-additional-cost services and qualified employee discounts discussed in Episode 17, but don’t make the cut for working condition fringes.

One additional group does qualify: bona fide volunteers at nonprofit organizations can receive working condition fringes without it being treated as compensation. This provides helpful flexibility for tax-exempt entities, though Wells emphasizes that understanding what organizations can provide to volunteers without converting them to compensated workers requires careful attention to the rules.

No Discrimination Rules Apply

Unlike many benefit programs, working condition fringes come with no nondiscrimination requirements. An employer can provide a company vehicle to one employee while not offering similar benefits to others. Highly compensated employees can receive working condition fringes that aren’t available to rank-and-file workers. This flexibility allows businesses to target these benefits where they’re most needed operationally.

Substantiation Requirements Still Matter

The absence of nondiscrimination rules doesn’t mean working condition fringes don’t have documentation requirements. If IRC Section 274 imposes strict substantiation requirements on a particular type of expense, those same requirements apply when the expense is provided as a working condition fringe.

Wells points to club memberships as a prime example. IRC Section 274(a)(3) disallows deductions for membership dues in clubs organized for business, pleasure, recreation, or other social purposes, such as country clubs, chambers of commerce, civic organizations, and similar groups. When clients argue these memberships generate business connections, Wells notes “just because something seems like it should be deductible, or it seems unfair that it’s not deductible, that’s just simply what the law says.”

An employer can still pay for such memberships, but they must include the value in the employee’s compensation and deduct it or exclude it from compensation and forgo the deduction entirely.

When providing cash advances for working condition fringes, employers must require employees to use the cash for specific deductible activities, verify correct use with receipts, and return any unspent cash. This differs significantly from de minimis fringes.

Getting the Details Right with Company Vehicles

Employer-provided vehicles are a common working condition fringe benefit. We’re not talking about business owners using vehicles for personal transportation, but true company vehicles like the trucks driven by HVAC technicians, the vans operated by plumbers, and vehicles used by pest control professionals.

The excludable portion is the total annual value of the vehicle multiplied by the percentage of business-use miles. “Even though it’s company owned, there still needs to be a written, contemporaneous mileage log,” Wells says, emphasizing a critical point. Digital tracking counts, but the documentation must exist.

When an employee keeps the vehicle overnight to make an early morning service call, that commute home and back to work counts as personal use. The substantiation requirements don’t relax simply because the employer holds the title.

If multiple employees share vehicles throughout the year, their combined legitimate business mileage counts in both the numerator and denominator of the business-use calculation. But if specific employees use designated vehicles during identifiable periods, the organization must maintain records separately.

Other Working Condition Fringes

Product testing is another excludable category with specific requirements. Employers must limit product availability to the testing period, require return of products afterward, and collect detailed employee reports. Notably, directors and independent contractors don’t qualify for this particular exclusion, so employers must report test products provided to them as compensation.

Job-related education qualifies as a working condition fringe when it meets requirements under IRC Section 127. Wells devoted Episode 7 entirely to deductible education costs, which provides deeper guidance on this topic.

Business travel expenses, including flights on employer-provided aircraft, can be excluded when legitimately deductible. But personal elements, such as tickets for children, personal destinations, or accompanying family members without documented business purpose, are includable in income.

For clients in higher-risk environments, enhanced security for company vehicles can qualify as working condition fringes. The key is documented specificity: general safety concerns don’t suffice. There must be evidence of actual threats, such as death threats, kidnapping risks, or recent violent incidents, and security must be part of a comprehensive 24-hour protection program.

De Minimis Fringe Benefits: When “Too Small to Count” Actually Counts

While working condition fringes help employees perform their jobs, de minimis fringes address the smaller perks that boost morale and show appreciation. The standard seems simple: if a benefit’s value is so small that tracking it would be unreasonable or administratively impracticable, employers can provide it tax-free.

But don’t let “too small to count” suggest this category operates without rules. The de minimis standard contains specific requirements, and one absolute prohibition that catches many employers off guard.

The Individual Employee Test

Frequency matters when determining whether a benefit qualifies as de minimis, and the analysis focuses on each individual employee. “Providing a daily meal to a single employee is not a de minimis fringe benefit with respect to that employee,” Wells explains, “even though if we were just looking at the number of meals provided annually to all employees, it might be a relatively small number.”

The exception comes when tracking individual frequency becomes administratively difficult. Wells offers the copying machine example. If an employer ensures at least 85% of use is for business purposes, any personal use qualifies as de minimis. Nobody expects employers to count every personal page, so these rules eliminate that administrative burden.

The Absolute Cash Equivalent Prohibition

Here’s where many well-intentioned employers stumble: cash and cash equivalents are never excludable as de minimis fringes. No exceptions. The rationale is, it’s never administratively impracticable to account for cash.

This creates counterintuitive outcomes that confuse clients. The holiday ham or turkey is the textbook de minimis fringe, literally cited by Congress when explaining IRC Section 132. But when one employer switched from holiday hams to $35 gift certificates for local grocery stores, the IRS ruled those certificates were cash equivalents and thus no longer excludable.

“Even though in terms of frequency and amount, it might appear de minimis, I can specifically and administratively identify how much was spent so that is never going to be excludable,” Wells emphasizes.

Office Snacks and the TCJA Changes

Coffee, donuts, and soft drinks in the office are another classic de minimis fringe benefit. So are occasional meals or meal money provided specifically for employees working overtime, with emphasis on “occasional” and the overtime connection. Company parties, picnics, and group meals (including guests) also qualify.

These categories generated confusion following the 2017 Tax Cuts and Jobs Act. “I saw a lot of social media posts claiming the legislation made office snacks, donuts, and soft drinks nondeductible and includable. Neither one of those is true,” Wells says, clarifying an important misconception.

What actually changed is pre-TCJA, these items were 100% deductible. Post-TCJA, office snacks and occasional meals became 50% deductible. They’re still deductible, just at half the rate. They remain fully excludable from employee compensation.

What did become nondeductible after 2025 are expenses for employer-operated eating facilities—essentially cafeterias that charge employees for food. But basic office snacks are 50% deductible for employers and still tax-free for employees.

Employer-Provided Cell Phones

Cell phones occupy an interesting position, potentially qualifying under both working condition and de minimis rules. The key is why the employer provides the phone.

If they provide it so the employee can be on-call outside normal hours, then the business use qualifies as a working condition fringe and personal use as de minimis. As a result, the entire value is excludable for the employee and deductible for the employer.

However, phones provided to boost morale or included in employment contracts as compensation don’t qualify. The phone must serve the employer’s operational need for employee availability.

Holiday and Special Occasion Gifts

Employers can provide occasional, non-extravagant gifts for holidays, birthdays, achievements, illnesses, or family crises as excludable de minimis fringes. Wells notes these should be “one off or occasional, maybe annual. Probably not more often than that.”

But the cash equivalent prohibition applies fully here. A $35 gift basket is excludable. A $35 gift card to the employee’s favorite restaurant must be included in compensation. Same dollar amount, same thoughtful intent, completely different tax treatment.

Common Pitfalls and Non-Excludable Benefits

Wells identifies several benefits that commonly trip up employers who assume they’re tax-free:

Season tickets to sporting or theatrical events cross the line into reportable compensation, though a single occasional ticket might qualify as de minimis.
Commuting use of employer-provided vehicles remains personal use that must be tracked and potentially reported, even for company-owned vehicles used primarily for business.
Private country club or athletic facility memberships don’t qualify as excludable fringes, despite potential business networking value.
Group term life insurance on a spouse or child creates taxable compensation, as only coverage on the actual employee qualifies for favorable treatment.
Personal use of employer facilities like a beach condo or hunting lodge generates reportable income. Wells notes clients often want to rent cabins for “strategic planning” retreats, but “it would be a stretch to say that was an actual business expense.”

The Documentation Imperative

Throughout the episode, Wells emphasizes that “documentation is key.” Even without nondiscrimination requirements, written policies and records protect both employers and employees.

Best practices include:

Maintaining detailed records of what benefits were provided, when, and to whom
Tracking benefit values even for seemingly trivial items
Ensuring you’ve satisfied substantiation requirements under IRC Section 274
Documenting eligibility criteria in writing

“It’s always best practice to clearly document in writing who earns what kinds of benefits,” Wells advises, “even if there are no nondiscrimination rules for the particular kind of benefit.”

Turning Fringe Benefit Rules Into Client Value

Working condition fringes and de minimis benefits offer employers meaningful ways to support their workforce beyond traditional compensation. Company vehicles enable service technicians. Cell phones keep employees connected. Office coffee makes the workplace pleasant. Holiday gifts acknowledge contributions. When structured correctly, these benefits are deductible for employers and invisible on employee W-2s.

For tax professionals, mastering these distinctions creates immediate value for business clients. Every employer wants to provide meaningful benefits. Guiding them toward tax-efficient structures while avoiding pitfalls demonstrates expertise that justifies advisory relationships.

Listen to the full Tax in Action episode for Jeremy Wells’ complete analysis, including additional examples and nuances not covered here.