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Jeff Ring, CPA

Directors' Benefits: Form 1099-MISC vs. Form W-2

2013-02-13

If your financial institution provides its directors with compensation in the form of directors’ fees and benefits, you already know that the reporting requirements for each type of compensation can be complicated.

Reporting the compensation incorrectly to the directors can have negative tax consequences. To help you determine the correct IRS form for your situation, we’ve laid out the most common scenarios and their respective forms.

Directors’ fees

A corporate director is considered to be an independent contractor, not an employee, in the eyes of the IRS. This means that your financial institution should report fees paid to a director on Form 1099-MISC and not on Form W-2, which is used for employees. The income reported on the director’s individual income tax return will be subject to self-employment taxes.

Since the IRS views directors as being in the “business” of serving as a director, they are entitled to deduct ordinary and necessary expenses of carrying on the business on their individual income tax returns. Typically, these expenses are deducted as business expenses, not itemized deductions, and are not subject to limitations based on income. However, if the director is also an investor in the corporation, the expenses may be treated as investment expenses, in which case they would be reported as miscellaneous itemized deductions and would only be deductible to the extent they exceed 2% of the director’s adjusted gross income.

Reimbursements

If your institution reimburses a director for expenses incurred in relation to duties, the reimbursements should be included on Form 1099-MISC as additional compensation. Directors who file income tax returns as sole proprietors are permitted deductions for amounts reimbursed and included on Form 1099-MISC. For example, if $1,000 of travel expenses were reimbursed to a director, the reimbursements would be included on Form 1099-MISC as additional compensation and the expenses would be deductible against the income, effectively “zeroing out” the additional income reported on Form 1099-MISC.

This is different from employees who receive reimbursement, who would not include the reimbursement in income, nor be entitled to deduct the same expenses on their personal income tax returns.

Planning opportunity

Directors may be able to postpone paying tax on income earned in connection with their duties by making deductible contributions to a pension or profit-sharing plan for self-employed individuals known as a Keogh plan. Directors are entitled to make deductible contributions up to 20% of qualifying income (up to a maximum of $50,000 in 2012). Directors’ participation in Keogh plans would be in addition to other qualified pension and profit-sharing plans in which they already participate as employees, and contributions to those other plans do not count toward the limit for contribution to the Keogh plan.

Other types of benefits

In addition to fees for their services, your directors may receive compensation in the form of benefits. The way in which your financial institution reports these benefits to the directors can vary depending on the type of benefit and the manner in which it is paid.

  • HSA contributions: Since a director is not considered an employee for benefits purposes, HSA contributions made on behalf of directors are included in their income and reported on Form 1099-MISC. This income will be aggregated with their other director compensation and may be subject to self-employment tax. Assuming they meet certain requirements, directors should be permitted a deduction for the HSA contributions on their individual income tax returns.
  • Term life insurance: Term life insurance provided to directors is included in their income and reported on Form 1099-MISC. This income is subject to self-employment tax. The amount that should be reported is the premium payment made on behalf of the director. The same rules apply to group term life insurance premiums.
  • BOLI: Under plans in which a director’s beneficiary may receive a death benefit (e.g., the beneficiary receives the benefit in excess of the cash surrender value), an amount of imputed income should be reported to the director on Form 1099-MISC. As this area can be very complex, financial institutions should work with their benefits consultants and outside advisors to compute any amounts that may be considered imputed income. Failure to report the imputed income may result in taxation of the life insurance death benefit.
  • Director and employee: The rules become more complicated when directors also perform activities that would cause them to be considered current or former employees under the IRS employment tax rules. It depends primarily upon whether or not the director performs services that are not directorial in nature, and whether or not those services are performed under an employer/employee relationship. The guides for determining whether a common law employment relationship exists are found in section 31.3121(d)-1(c) of the regulations.

Any compensation you pay to directors in their capacity as employees should be reported to the director on Form W-2 and will be subject to employment taxes. The Internal Revenue Code provides specific exclusions from taxation that apply to employees and not directors. In these circumstances, the institution would need to issue both a Form 1099-MISC and a Form W-2 to the director-employee. The institution would also need to have the director complete Form W-4, and withhold federal and state income taxes on the W-2 wages accordingly.

There are many other forms of compensation and benefits that may be paid to a corporate director. Therefore, we recommend a thorough review of all compensation plans including establishing a monitoring process to properly account for plan modifications and changes. Each form of compensation should be reviewed independently to determine both the amount of compensation and the manner in which it should be reported.