Information return

What Is Information Return?

An information return is a document filed with the tax authority, such as the Internal Revenue Service (IRS) in the United States, by a third party to report certain payments made to, or transactions conducted with, another taxpayer. Unlike a tax return, an information return does not calculate or report tax due, but rather provides data that helps the tax authority verify income, deductions, and other financial activities for effective tax compliance. These forms are critical in the broader category of tax administration, enabling authorities to match reported income and ensure accuracy in the tax system.

History and Origin

The concept of third-party information reporting is deeply intertwined with the evolution of income taxation. While the first federal income tax in the U.S. was established during the Civil War, the modern system of broad income tax and associated reporting began after the ratification of the 16th Amendment in 1913, which granted Congress the power to lay and collect taxes on incomes. The initial income tax forms, like the first Form 1040 introduced by the Treasury Department in 1914, primarily relied on individuals to report their own income.⁷,⁶,⁵

Over time, as the tax system grew more complex and the number of taxpayers expanded, the government recognized the need for third-party verification to enhance compliance and reduce tax evasion. The introduction and expansion of information returns, such as the wage and tax statement (Form W-2) for employee wages and various Form 1099 series forms for other types of income, became crucial tools for this purpose. These reporting requirements shifted a significant burden of income verification from the taxpayer to the payer, creating a powerful check-and-balance system.

Key Takeaways

• An information return is a document filed by a third party with the tax authority, reporting payments or transactions to another taxpayer.
• It serves to inform the tax authority about income earned by a taxpayer, but does not calculate or report the tax liability itself.
• Common examples include forms reporting wages, dividends, interest income, and non-employee compensation.
• Information returns are a cornerstone of modern tax administration, significantly improving compliance rates.
• Payers are typically required to furnish a copy of the information return to the recipient taxpayer and file another copy with the IRS.

Formula and Calculation

Information returns do not involve a "formula" in the financial calculation sense, as their purpose is to report specific monetary amounts or transaction details, not to derive a new value. Instead, they require the aggregation and accurate reporting of predefined data points. For example, a payer reports the total amount of interest income paid to an individual over a calendar year, or the gross proceeds from a sale of securities in a brokerage accounts. The "calculation" involved is simply summing up all reportable payments made within the specified reporting period.

Interpreting the Information Return

For the recipient of an information return, such as a Form W-2 or various Form 1099s, the document is a critical piece of evidence used to prepare their annual tax return. Each information return details specific types of income, payments, or other financially relevant data that must be reported on the individual or business tax forms. For instance, the amount reported on a Form 1099-DIV for dividends received should be included when calculating the taxpayer's total taxable income.

The IRS and other tax authorities use these information returns to cross-reference the data reported by taxpayers on their own returns. This matching process is highly effective in identifying discrepancies, which can flag a return for further scrutiny, potentially leading to an audits. Therefore, taxpayers should carefully review all information returns they receive and ensure their own tax filings accurately reflect the reported amounts.

Hypothetical Example

Consider Jane, an independent graphic designer who completes several freelance projects during the year. One of her clients, ABC Marketing, pays her a total of $7,500 for services rendered over the year. Because ABC Marketing paid Jane more than $600 for her services in the course of their trade or business, they are required to issue an information return.

At the end of the year, ABC Marketing prepares and sends Jane a Form 1099-NEC, Nonemployee Compensation, showing the $7,500 paid to her. They also file a copy of this Form 1099-NEC with the IRS. When Jane prepares her personal tax return, she uses this Form 1099-NEC to accurately report her freelance income. The IRS can then match the income reported by Jane on her Schedule C (Profit or Loss from Business) with the Form 1099-NEC filed by ABC Marketing, helping to ensure tax compliance.

Practical Applications

Information returns are fundamental to the operation of modern tax systems across various financial sectors and for numerous types of income. Their practical applications include:

• Income Reporting: Forms like W-2 (wages), 1099-NEC (non-employee compensation), 1099-INT (interest income), and 1099-DIV (dividends) ensure that most forms of income are reported by payers.
• Investment Activity: Forms such as 1099-B report proceeds from broker and barter exchange transactions, including sales of stocks, bonds, and other securities, aiding in the accurate reporting of capital gains and losses.
• Retirement Contributions and Distributions: Forms like 5498 report contributions to Individual Retirement Arrangements (IRAs), while Forms 1099-R report distributions from pensions, annuities, and retirement plans.
• Mortgage Interest and Student Loan Interest: Form 1098 reports mortgage interest paid, and Form 1098-E reports student loan interest paid, allowing taxpayers to claim applicable deductions.
• Government Payments: Form 1099-G reports certain government payments, such as unemployment compensation or state tax refunds.

These forms are critical for the IRS's ability to verify income and deductions. Taxpayers are assigned a unique taxpayer identification number (TIN), usually a Social Security Number (SSN) or Employer Identification Number (EIN), which is used by financial institutions and other entities when preparing information returns. This TIN allows the IRS to link payments reported by various third parties directly to the taxpayer's account. In recent years, the IRS has modernized its processing systems, including the Information Returns Intake System (IRIS), to handle the increasing volume of electronically filed information returns.⁴

Limitations and Criticisms

While information returns are highly effective in promoting tax compliance, they are not without limitations. One primary criticism is the burden they place on businesses and organizations responsible for issuing them, requiring robust accounting systems and adherence to detailed IRS specifications outlined in publications like Publication 1179.³ Failure to comply with these reporting requirements can lead to penalties for inaccurate or late filings.

Another limitation is that information returns typically report gross amounts, not net income. For example, a Form 1099-NEC reports gross payments to an independent contractor, but does not account for their business expenses. This means the taxpayer still needs to accurately track and report their deductions to arrive at their actual taxable income.

Furthermore, while information reporting significantly boosts compliance for income that is clearly reported by a third party, it has a less direct impact on income streams where such reporting is absent or difficult to implement, or on unreported income from illegal activities. Research suggests that compliance rates are notably higher for income subject to third-party reporting and withholding compared to income not subject to these mechanisms.²,¹ This disparity highlights that reliance on information returns alone cannot fully close the "tax gap," which is the difference between taxes owed and taxes paid.

Information Return vs. Tax Return

The terms "information return" and "tax return" are often confused, but they serve distinct purposes in the tax system.

The primary difference lies in their function: an information return informs the tax authority about a financial event, while a tax return aggregates all such events for a taxpayer to determine their overall tax liability.

FAQs

What is the main purpose of an information return?

The main purpose of an information return is to provide the tax authority with details about payments made to, or transactions involving, a taxpayer by a third party. This helps the tax authority verify the accuracy of the taxpayer's own tax return and promotes tax compliance.

Who is required to file information returns?

Generally, any person or entity engaged in a trade or business that makes certain types of reportable payments to others during the calendar year is required to file information returns. This includes employers, financial institutions, investment brokers, and businesses that pay independent contractors.

What happens if I don't receive an information return I'm expecting?

If you expect an information return, such as a Form W-2 or a Form 1099, but do not receive it by the typical deadline (often late January or early February), you should first contact the payer. If you still cannot obtain it, you can contact the Internal Revenue Service for assistance, as you are still responsible for reporting all your income regardless of whether you receive the form.

Are all types of income reported on information returns?

No, not all types of income are reported on information returns. For example, cash payments for casual services or small amounts of income (often below a certain threshold like $600 for many 1099 forms) may not trigger an information return filing requirement. However, taxpayers are still legally obligated to report all their income on their tax return.