Implement strong procedures today, don’t wait until year-end.
I know the deal, having been a controller for 20 years. You got through the 1099 season and said to yourself, “we can’t spend this much time and do it this way again next year!” But then your attention turns to the annual audit, and then an acquisition, and then a system conversion, and then a staff shortage, and before you know it, January is here again. Your focus turns toward issuing the year-end financials so you delegate the 1099 job to someone on your staff, hoping that you can do a quick review of the work and then move on.
Your staff runs into the typical issues again; misfiled, incorrect and missing W-9s. They aren’t able to get a W-9 for some vendors with no contact information. In addition, there isn’t a really good process to determine what payments should be 1099 reportable that you can review and feel comfortable with. You start with your work from last year, but was that really correct? You spend more time than you want, pull together a list of reportable payments that you hope is correct and file the 1099s the last week of January. The risk of audit seems low, so you move on.
Understand the IRS’s new focus on Form 1099 audits
Materiality works in a lot of areas, however, when it comes to 1099s it is not advised. The IRS is no longer playing around in this area. Several years ago, the IRS issued a memorandum that updated their employment audit procedures to include a review of information returns. The memorandum states that IRS examiners must now “address whether the appropriate information returns were filed for any reportable payments (e.g. Form 1099-MISC…)” during an employment audit. This significant increase in 1099 enforcement came from the Treasury Inspector General’s report titled “Due to the Lack of Enforcement, Taxpayers Are Avoiding Billions of Dollars in Backup Withholding.”
If you are audited, it doesn’t take much for penalties and backup withholding assessments to add up. An example is the best way to highlight this. Let’s assume you added 200 vendors during the year and issued 50 1099 forms at year-end. You were able to get all but ten W-9s from your vendors by January 31st. However, you didn’t realize that you misclassified five vendors as corporations and forgot that legal settlements paid to an attorney often have to be reported to both the claimant and the attorney. There were just a few errors, however, they resulted in substantial penalties.
The final assessment of $50,730 came from just ten vendor payments, with the majority of the exposure related to backup withholding. Also, consider that the example does not include any interest assessments. Clearly, it is imperative to get a W-9 form from every vendor that is correct and complete. Secondly, it is important to be absolutely certain what payments are reportable and why.
Know the penalties assessed by the IRS
1099 filing penalties
Penalties can be significant and numerous for companies that don’t comply with IRS information reporting regulations.
Penalty amount - 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 returns submitted late to the IRS:
- $50 per information return you correctly file within 30 days after the due date; maximum penalty of $556,500
- $110 per information return you correctly file more than 30 days after the due date but by August 1; maximum penalty of $1,669,500
- $270 per information return if you file after August 1 or you do not file required information returns; maximum penalty of $3,339,000
- $550 or more per information return if any failure to file a correct information return is due to intentional disregard; there is no maximum penalty
In addition, the same penalties above are assessed at the same amounts on a failure to provide a correct 1099 statement to the vendor or independent contractor. The penalty for not filing a correct information return with the IRS is separate from the penalty for not providing a 1099 statement to your vendor.
You may be subject to a penalty:
- If you fail to file timely
- If you fail to include all information required to be shown on a return
- If you include incorrect information on a return
- If you file on paper when you were required to file electronically
- If you report an incorrect TIN
- If you fail to report a TIN
- If you fail to file paper forms that are machine readable.
For more information on penalties see the General Instructions for Certain Information Returns.
Backup withholding penalties
Although penalties can be significant, it is the backup withholding assessment that holds the greatest exposure. Backup withholding is an IRS requirement for companies to withhold 24% of a payment to a U.S. vendor in certain circumstances and remit the amount to the IRS. Companies are required to make an initial request for the TIN number (done with a W-9 form) when the first payment is made to the vendor.
If the vendor does not provide a W-9 form when you initially ask for it, you must begin backup withholding. If you don’t begin backup withholding when required, you could be responsible for the entire amount that was not withheld. So, if a company pays a vendor $100,000 during a calendar year and does not withhold the required 24%, it could be required to pay the $24,000 in backup withholding itself to the IRS.
For more information on backup withholding, see IRS publication 1281, Backup withholding for missing and incorrect name/TINs.
Implement a plan to reduce your risk of penalties today
There are several ways to limit your exposure to Form W-9 penalties.
Get a W-9 form before every vendor payment
Due to the potential risk of 24% backup withholding being assessed on the ENTIRE amount paid to a vendor, it is imperative that you obtain a W-9 form from every vendor. Make sure you have an air-tight process in place to ensure you receive a W-9 form prior to the first payment to your vendor. You should also have a way to track the W-9s requested and follow-up to ensure receipt. Avoid looking to catch-up on missing W-9s at year-end. At that point you will find vendors that are no longer in business, don’t have good contact information, or won’t give you a W-9 to avoid being issued a 1099 form.
The exposure from even one missing W-9 form is too great. In the example above two payments of only $90,000 were assessed $21,600 in backup withholding due to missing W-9s. If the payments had totaled $500,000, a 24% backup withholding assessment would be $120,000. Backup withholding costs can be significant and would be an expense to the company as payment to the vendor had already been made.
It is also important to ensure that the W-9 forms you receive are complete and correct. W-9s that are missing the TIN number, name, or signature can be subject to the 24% backup withholding as well. Mismatches between the name and the TIN number can also result in “B” notices from the IRS. These notices create additional work and increase exposure to additional penalties.
Ensure a solid understanding of 1099 regulations
Make sure you have a solid understanding of the IRS regulations for 1099 forms. For each reportable payment that is not reported to the IRS and the vendor, the penalty would be $540 if not caught before August 1st.
File electronically when required
If you are required to file 250 or more information returns during the year, you must file electronically. The 250-or-more requirement applies separately to each type of form. However, be aware that the IRS is looking at changing this rule. See our blog article IRS proposes changes to electronic reporting requirements.
Make sure you follow the IRS guidelines by filing Form 1096 with the IRS and sending Form 1099 to your vendors timely. See our blog article Avoid the penalty, 1099-MISC due dates for 2020.
Use W9manager to streamline your entire process
W9manager was built to help you complete most of your 1099 work before the season even starts.
- Request electronic W-9s from vendors with automated reminders
- Give anyone in your organization access to request W-9s and receive them back centrally
- Track all outstanding W-9s that you haven’t received
- Receive W-9s that are done right, as vendors and independent contractors use our step-by-step process to create W-9s
- Know what vendor payments are reportable on a 1099-MISC using our guided process
- Stop sending paper 1099s when vendors opt-in for electronic reporting
Try W9manager for free for 14 days at www.w9manager.com.
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.