10 Best Practices for W-9/1099 Compliance in 2021
Organizations are required to report certain “reportable” payments made in the course of their trade or business to the IRS. This process is known as “Information reporting”. There are over 30 information tax returns that are required to be submitted to the IRS.
This process allows the IRS to cross-check the income reported from these organizations with the income reported on an individual and entity’s tax return. This in turn helps increase the likelihood that all income received is reported and, therefore, that all tax is paid.
In this article we will look at the best practices for 1099 compliance in 2021.
Ensure Correct Classification
It is critical that workers are classified correctly as either an employee or an independent contractor. The potential liabilities can be substantial if a worker is incorrectly classified. And the laws may differ between the IRS, state law and the Fair Labor Standards Act. The rules listed here are for the IRS.
The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done. Small businesses should consider all evidence of the degree of control and independence in the employer/worker relationship. Whether a worker is an independent contractor or employee depends on the facts in each situation.
Behavioral Control – A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised. Look at the type of instructions given, the degree of instruction, the evaluation systems, and worker training.
Financial Control – A worker is an employee when the business has a right to direct or control the financial and business aspects of the worker’s job. Did the company provide the equipment the worker uses? Does the worker have the opportunity for profit or loss? What is the method of payment – regular wage or payment by the job? Are the worker’s services available to the market?
Relationship -The type of relationship also depends upon how the worker and business perceive their interaction with one another. Are there written contracts which describe the relationship. Is the worker provided employee type benefits? A more permanent relationship and services seen as a key aspect of the regular business of the company point toward an employee relationship.
Obtain a Correct & Complete W-9 Form
Form W-9 is used by companies to obtain the tax classification and Taxpayer Identification Number (EIN or SSN) from vendors and independent contractors they pay. This information is then used to determine if the company is required to send the vendor or contractor the related “information return”.
The best practice for companies is to request that ALL vendors and contractors complete Form W-9 prior to releasing payment to them.
The W-9 form should only be completed by what the IRS calls a “U.S. person”. Some examples of U.S. persons include:
- Individuals who are a U.S. citizen or a U.S. resident alien.
- Partnerships, corporations, companies, or associations created or organized in the United States or under the laws of the United States are also U.S. persons.
- An estate (other than a foreign estate)
- A domestic trust
If the vendor or contractor is not a U.S. person, they should not use this form. They will likely need to provide Form W-8 or Form 8233. Also, check the date in the top left corner of the form as it is updated occasionally by the IRS. The current revision should read “Rev. October 2018″.
One of the benefits of using W9manager is the way in which we help vendors create the most correct and complete W-9 form. We walk them through a step-by-step guided process with contextual help on every step. This helps ensure that each field is complete and that you get a correct and complete W-9 form the first time.
For additional information see the following:
TIN Matching is a free online service from the IRS that is a huge help in avoiding “B” notices. The name on Line 1 of the W-9 is matched against the TIN number provided. If there is an issue, you can resolve it at the time a W-9 is received and BEFORE 1099s are filed. The best practice is to TIN match each W-9 form as received and then again at year-end for all payees receiving a 1099 form.
It is difficult and time-consuming to receive authorization to the TIN matching program. So, it is important to request access months in advance of the 1099 season. Apply for access at the following IRS link. If you need immediate access, W9manager provides the ability to bulk TIN match directly with the IRS and receive a response within 24 hours. Click here to learn more.
For more information on TIN matching see our article, The importance of TIN Matching.
Avoid Backup Withholding and Annual Solicitation Requirements
Payments including rents, royalties, commissions, nonemployee compensation and certain other payments are subject to IRS backup withholding at 24%. Failure to backup withhold when required can result in the payor itself being held responsible to pay the entire 24% to the IRS. So, if a company pays $1,000,000 to a vendor and did not appropriately backup withhold the 24%, the company itself could be responsible to pay $240,000 to the IRS plus penalties.
Companies can avoid backup withholding in most cases by obtaining a properly completed W-9 form. For more on backup withholding see our article, Are you at risk of IRS backup withholding penalties?
Were you unable to obtain your payee’s TIN number when a payment is made? The IRS requires the payer to not only backup withhold and but also begin annual solicitations. A solicitation is a request for a payee’s correct TIN and the W-9 form is typically provided in response. The initial solicitation is required when a payee opens an account or when the transaction occurs. A first annual and second annual solicitation are required at the end of each of the following years. For more information see our article, Beware of the IRS’s W-9 annual solicitation requirements.
Track Progress During the Year
The most important step to successfully managing vendor payment compliance is setting up a solid process during the year. Ensure you get a correct and complete W-9 form from every vendor during the year, file the form so you can find it, and record the W-9 information to help you make correct 1099 reportability decision. One of the best things about W9manager is the vendor summary screen where you can see the status of all vendors W-9s at any time.
Identify Nonreportable Payments
Once you have reconciled your payment registers for the calendar year, it is time to determine which payments are 1099 reportable and which ones are not. Our suggested 1099 best practice here is to identify the payments that you have made that can be eliminated as nonreportable payments. This will likely be a majority of your payments. Some of the more common payments that are nonreportable are listed on the slide below. For an in-depth discussion of nonreportable payments see our 1099 Best Practices webinar.
Identify 1099 reportable payments
Once you have identified the nonreportable payments it will be much easier to identify the reportable payments. Unfortunately, the regulations that cover 1099s and information reporting are over 175 pages long and include 75,000 words! Listed below are some of the more common payments that are reportable. For something to be reportable both the payment type and the tax classification need to be reportable.
Form 1099-NEC (Nonemployee Compensation)
Effective for calendar year 2020 the IRS has resurrected the 1099-NEC form. The deadline for filing is January 31, 2021. Nonemployee compensation (NEC) will no longer be reported on 1099-MISC in Box 7. NEC will be reported on 1099-NEC Box 1. The 1099-NEC is not included in the Consolidated Federal/State Filing Program. So, this form will need to be directly filed in the majority of states that have an income tax. For state filing information see the W9manager Academy state compliance section. File 1099-NEC when NEC calendar year payments total at least $600.
Form 1099-MISC (Miscellaneous)
For calendar year 2020 Box 7 has been moved to the 1099-NEC, Box 1. Several other of the 1099-MISC boxes have been rearranged. List below are some of the more common payments reportable on the 1099-MISC. File 1099-NEC when these calendar year payments total at least $600.
Box 1 Rent
- Real estate rentals paid for office space
- Machine rentals – bulldozer, copy machine
Box 2 Royalties >= $10
- From oil, gas or other mineral properties (excluding surface royalties)
- Patents, copyrights, trade names and trademarks
- Royalties paid by a publisher directly to an author or literary agent
Box 3 – Other Income
- Reportable income of $600 or more not reported in one of the other boxes or on the 1099-NEC
- Prizes and awards that are not for services performed
- Amounts paid to a winner of a sweepstakes not involving a wager
- Generally, all punitive damages, any damages for nonphysical injuries or sickness, and any other taxable damages.
Box 4 – Federal income tax withheld
- Report any backup withholding
Box 6 – Medical and health care payments
- Payments to each physician or other provider of medical or health care services.
- Corporations are not exempt
- Payments for prescription drugs are not reportable.
- Payments made to a tax-exempt hospital or extended care facility or to a hospital or extended care facility owned and operated by a U.S. government entity are typically not reportable.
Box 7 – Direct sales of $5,000 or more
- Payer made direct sales of $5,000 or more of consumer products to a buyer (recipient) for resale
The examples list above are some of the more common payments that companies deal with when processing 1099s. However, because information reporting rules are complex, we created a process within W9manager to help you identify whether a payment is reportable or not. Once you request and accept your vendor’s W-9 form you will be taken to our reportability section. There you can select the type of payment made and we will tell you if the payment is reportable on the 1099 form. Our matrix includes almost 4,000 options!
Best Practices for Filing 1099s
Once you have compiled your list of 1099 reportable payments it is time to file the 1099s with the IRS and send 1099 statements to your vendors. We recommend using an online service to file electronically with the IRS. W9manager partners with Tax2efile to handle 1099 processing. Users that manage their vendor W-9s in W9manager can just click a button and export a spreadsheet that lists all of their 1099 reportable vendors. Just add the amount paid and import the spreadsheet directly into Tax2efile. Tax2efile will then file with the IRS, mail out 1099 statements, email a link to the 1099 and file with the state. Currently the IRS requires electronic filing when a company has 250 or more returns. This will be reduced to 10 over the coming years.
1099 forms that are filed with the IRS are automatically included in the Combined Federal/State Filing program. The Combined Federal/State Filing (CF/SF) Program was established to simplify information returns filing for payers. Through CF/SF, the IRS electronically forwards information returns (original and corrected) to participating states. This typically eliminates the need to file these 1099s with the state directly.
IMPORTANT! It is important to note that IRS Publication 1220, Specifications for Electronic Filing of Forms, was updated in September 2020 and did not include the 1099-NEC in the CF/SF program. 1099-NEC filers will need to file their calendar year 2020 1099-NEC forms directly with most states. This is another great reason to file electronically. For state filing information by state see the W9manager Academy state compliance section.
Avoid “B” Notice Requirements
If you file 1099s with name/TIN mismatches, missing TINs or other errors the IRS will likely send you a CP2100 notice (error notice). Once you receive the notice you have a brand-new set of IRS regulations and procedures that you must follow. See the flow chart to the right for an example.
“B” notices, or backup withholding notices, are often required to be sent to your vendors. It is very helpful to avoid having to deal with the “B” Notice process as there are additional penalties and fines that can be assessed if the process is not completed correctly. The best way to avoid receiving the CP2100 notices is to TIN match all the 1099 records with the IRS database before filing them with the IRS.
File 1099s Timely
Penalties can be significant and numerous for companies that don’t comply with IRS information reporting regulations. The amount of the penalty for not correctly filing a 1099 form is based on when you file the correct return. The penalties are as follows for 1099 returns submitted late to the IRS (calendar year 2020):
- $50 per information return you correctly file within 30 days after the due date; maximum penalty of $571,000
- $110 per information return you correctly file more than 30 days after the due date but by August 1; maximum penalty of $1,713,000
- $280 per information return if you file after August 1 or you do not file required information returns; maximum penalty of $3,426,000
- $570 or more per information return if any failure to file a correct information return is due to intentional disregard; there is no maximum penalty
For more information see:
- Avoid the penalty, 1099-MISC and 1099-NEC due dates for 2021
- Form 1099 penalties are ridiculously high. What you must do NOW to avoid them.
Disclaimer – Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.