10 Best Practices for 1099 Compliance in 2021

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

Potential exposure for worker 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

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.

TIN Matching Codes

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.

Track W-9 Progression Chart

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.

Payments not reportable on a 1099 form

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

Attorney Fees vs Gross Proceeds

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!

The IRS provides a condensed set of Instructions for Forms 1099-MISC and 1099-NEC.  We also spend a significant amount of time on 1099 reportablity in our 1099 Best Practices webinar.

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.

Combined Federal/State Filing

 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

"B" Notice FlowchartIf 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

1099 Due Dates

For more information see:

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.

 

 

The importance of TIN Matching

What is TIN Matching? 

TIN Matching is a online service from the IRS that allows users to validate the legal name and TIN listed on a vendor’s W-9 form with the IRS database. A TIN number is a Taxpayer Identification Number and includes both a Social Security Number and an Employer Identification Number. The legal name, TIN and TIN type (1=EIN, 2=SSN, 3=Unknown) is entered into the IRS TIN Matching system and the IRS returns a code between 0 and 8. This code will tell you whether the name/TIN match combination matches IRS records. See the graphic below that details the nine possible codes.

9 Codes of IRS TIN Matching

Why should I TIN match?

One of the most common errors made on 1099 reporting is a mismatch between the TIN number and name. The name provided doesn’t belong with the TIN. Single-member LLCs often get this wrong. They don’t want to provide their Social Security Number so they list their individual name on Line 1 but provide the Employer Identification number of the LLC.

The IRS will easily catch these errors and send out CP2100 notices (error notices) to the companies that issued the 1099s. These error notices come with a new set of complex requirements including the need to withhold 24% from future vendor payments and send vendor B notices within 15 days. The 24% in backup withholding has to be remitted to the IRS per a strict Form 945 deposit schedule and there are additional annual solicitation requirements.

The bottom line – If you don’t follow the B notice requirements correctly, your company is subject to additional penalties and interest that relate to just the B notice process. TIN matching in advance of filing your 1099s with the IRS will reduce both the time you have to spend on the B notice process and the risk of IRS penalties and interest.

Best practice

The best practice is to individually TIN match each W-9 form as received and then bulk TIN match all of the payees at year-end that will be sent  a 1099 form. This will ensure that all of the name/TIN combinations are correct on the 1099s submitted. Note that TIN matching may only be done for vendor payments which might be reportable on a 1099 at year-end and are subject to backup withholding provisions.  See IRS section 3406(b)(1).

TIN matching process

Participants log into the IRS e-services application and then access the TIN matching application.

Interactive TIN matching – Twenty five name/TIN combinations can be entered for an immediate response.

Bulk TIN matches – A .txt can be submitted to the IRS with up to 100,000 W-9 name/TIN combinations and will receive a 24-hour response.

Click here to go to the TIN matching application.

Access to TIN matching application

It is difficult and time-consuming to obtain IRS authorization to the TIN matching program. So it is important to request access months in advance of your need. The employee applying for TIN matching must provide their own personal information to the IRS to access the TIN matching site. The information required includes the employees mobile number and specific personal financial account numbers. Two-factor authentication must also be set up.  Apply for access to the IRS TIN Matching application at IRS.gov.

W9manager bulk TIN matching service

W9manager provides a third-party TIN matching solution. This is typically used by subscribers that don’t want to provide personal information, don’t have the time to set up an IRS TIN matching account or don’t have the quantity of TIN matches that necessitate an account. W9manager offers a bulk TIN service that will TIN match up to 100,000 W-9 name/TIN combinations at one time. Click here to learn more.

What if I TIN match and still get a CP2100 notice?

IRC Section 6724 provides that any penalties under Section 6721 may be waived if the payer shows the failure to file a correct TIN on a 1099 return was due to reasonable cause and not willful neglect. Payers who use the TIN Matching system may establish due diligence and reasonable cause if the information contained in their records matches IRS records.

Additional Resources

See Publication 2108A for complete information on the TIN matching program.

 

Beware of the IRS’s W-9 annual solicitation requirements

The IRS requires that companies obtain a vendor’s TIN (Taxpayer Identification Number) before making a payment to them. The TIN is normally either a vendor’s Employer Identification Number or Social Security Number. Although using a W-9 form is typically not mandated by the IRS outside of interest, dividend, and broker payments, asking vendors to complete a W-9 form is the standard practice companies use to obtain a vendor’s TIN.

If a vendor refuses or neglects to provide a TIN, the company is required to withhold 24% of all 1099 reportable payments owed to the vendor that are subject to backup withholding rules.  The amounts withheld must then be remitted to the IRS.  Take note that some payments to vendors are not reportable and are not subject to backup withholding or annual solicitation requirements.  See our blog on backup withholding for more information.

In addition to backup withholding, the IRS requires companies comply with annual solicitation requirements if a W-9 form is not received before payment.  A solicitation is a request for a vendor’s correct TIN. The solicitation process should be completed and backup withholding should continue until the vendor provides their TIN. If you cannot show that you followed the annual solicitation requirements the IRS could assess you penalties for filing an information return with a missing or incorrect TIN.

Initial Solicitation – An initial solicitation should be made when a payee first opens an account or when the first payment occurs. A W-9 form is typically used for this request.  If the payee does not provide a TIN when you initially ask for it, you must begin backup withholding.  To avoid the risk of penalties from not obtaining a W-9 form and the significant administrative burden in backup withholding, companies typically ensure payments are not made until a W-9 is received.

First Annual Solicitation – If the payee does not provide a TIN when you initially ask for it, you must make the first annual solicitation by December 31st of the year in which the account is opened, or the transaction occurred. (for accounts opened before December) For transactions in December, the solicitation must be made by January 31st of the following year.

Second Annual Solicitation – If the payee does not provide a TIN after the first annual solicitation, you must make the second annual solicitation by December 31 of the year following the calendar year in which the account was opened or transaction occurred.

Conclusion – To avoid the administrative burden of backup withholding and annual solicitation requirements as well as the risk of penalties if done wrong, always get a W-9 form before paying your vendors!

What are the first and second annual solicitation requirements when sending out “B” notices?

If you file a 1099 form with a missing or incorrect TIN you may receive an error notice from the IRS also referred to as a CP2100 (large volume filers) or CP2100A (small volume filers) notice.  In this notice the IRS may require you to follow additional procedures including sending a “B” notice (backup withholding notice) to your vendor, starting backup withholding, and following annual solicitation requirements.  If these procedures are not followed you may be assessed additional IRS penalties.

CP2100(A) notices for a missing TIN: Begin backup withholding on any reportable payment you make and continue backup withholding until you receive a TIN. Remember that in some cases, the TIN must be certified (a signed W-9 form). In order to avoid a penalty for filing an information return that omitted the payee’s TIN, you must make a first annual solicitation for the TIN (generally by December 31 of the year in which the account is opened) and if a TIN is still not received make a second annual solicitation by December 31 of the following year. No annual solicitations are required in the years in which no reported payments are made.

CP2100(A) notices for an incorrect TIN: You must make up to two annual solicitations in response to the CP2100(A) Notice. You must send a B Notice within 15 business days after you receive a CP2100(A) Notice. If you receive a Proposed Penalty Notice (972CG) but not a CP2100(A) Notice, your annual solicitation must be made by December 31st of the year you received the Proposed Penalty Notice (972CG).

However, if you already sent a B Notice in the calendar year in response to a CP2100(A) Notice, you do not have to send another solicitation in response to the proposed penalty notice. If the IRS notifies you in the next calendar year that a TIN is still incorrect, you must make a second annual solicitation within 15 business days after you receive the second CP2100(A) Notice.

What is the relationship between the requirements to make an annual solicitation for a payee’s TIN and the requirements to send a “B” Notice?

Sending a “B” Notice to a payee in response to a CP2100(A) Notice satisfies the annual solicitation requirement to avoid a penalty for filing an information return with an incorrect TIN.

For additional information see Publication 1281, Backup Withholding for Missing and Incorrect Name/TIN(s) and Publication 1586, Reasonable Cause Regulations & Requirements for Missing and Incorrect Name/TINs.

How should an LLC fill out a W-9 form correctly? SSN vs EIN

Limited Liability Companies

The W-9 form seems like a simple form with only a few fields to be completed. However, the requirements for limited liability companies (LLC) are really complex and confusing.  From our experience the largest number of incorrect W-9s come from LLCs.  The best way to understand how LLCs should fill out W-9s forms is to first understand the four types of LLCs tax classifications and then look at the requirements for each.  This will then help us determine what tax classification is required to be selected on Line 3 of the W-9 form as well as the name and TIN to be used.

LLC W-9 Tax Classifications

Let’s look at each of these LLC tax classifications in depth and determine how the W-9 form should be completed for each.

W-9 LLC Tax Classification

C=C corporation tax status

An LLC that has filed form 8832 with the IRS has elected to be treated by the IRS for tax purposes as a C corporation.  This C corporation tax status applies to the LLC regardless of whether they are owned by one member or multiple members.  A member is an individual or company that owns the LLC.

Tax classification – An LLC that has made a C corporation election will check the limited liability company box on Line 3 of the W-9 and then write in “C” as the tax classification to the right of the LLC box.

Name – The name used on Line 1 of the W-9 form should be the legal name of the LLC as shown on its tax return.

TIN – The TIN provided should be the LLC’s Employer Identification Number.

S=S corporation tax status

An LLC that has filed Form 2553 with the IRS has elected to be treated by the IRS for tax purposes as an S corporation.  The S corporation tax status applies to the LLC regardless of whether they are owned by one member or multiply members.

Tax classification – An LLC that has made an S corporation election will check the limited liability company box on Line 3 of the W-9 and then write in “S” as the tax classification to the right of the LLC box.

Name – The name used on Line 1 of the W-9 form should be the legal name of the LLC as shown on its tax return.

TIN – The TIN provided should be the LLC’s Employer Identification Number.

P=Partnership tax status

An LLC that has not elected to be treated as either a C or S corporation by the IRS and is owned by more than one member is automatically treated by the IRS as a partnership for tax purposes.

Tax classification – A “multi-member” LLC will check the limited liability company box on Line 3 of the W-9 and then write in “P” as the tax classification to the right of the LLC box.

Name – The name used on Line 1 of the W-9 form should be the legal name of the LLC as shown on its tax return.

TIN – The TIN provided should be the LLC’s Employer Identification Number.

Single-member LLC (disregarded entity)

An single-member LLC that is owned by one member and has not elected C or S corporation tax status is “disregarded” by the IRS.  That means that the IRS does not see the LLC as separate from the owner.  Therefore, the IRS requires that the single-member LLC provide the owner’s information on the W-9 form and not the LLC’s information.

Tax classification – A single-member LLC (that has not elected C or S corporation tax status) will select the tax classification of the LLC’s owner on Line 3 of the W-9.

Name – The name used on Line 1 of the W-9 form should be the legal name of the owner of the LLC as shown on its tax return.

TIN – The TIN provided should be LLC owner’s TIN.

Typically a single-member LLC is owned by an individual.  When this is the case, the W-9 form should be completed with the individual’s name on Line 1, “Individual/sole proprietor or single-member LLC” checked as the tax classification on Line 3, and the individual’s Social Security Number provided as the TIN.

Disregarded entity

The name, tax classification and TIN entered on the W-9 should never be for a disregarded entity.  In the W-9 context, this means that you should never use the name of a single-member LLC (that has not elected S or C corporation tax status) on Line 1 or the LLC’s TIN.  You should always use the owner’s tax information.  If the direct owner of the LLC is also a disregarded entity, use the first owner of the LLC that is not a disregarded entity.

If the owner of the disregarded entity is a foreign person or entity, the owner must complete an appropriate Form W-8 instead of a Form W-9.  This is the case even if the foreign person has a U.S. TIN.

If a foreign LLC that is treated as a disregarded entity for U.S. federal tax purposes has a single owner that is a U.S. person, the U.S. owner’s name is required to be provided on line 1.

Line 2 – Business name/disregarded entity name/DBA

Line 2 is a completely optional field and is not reported to the IRS.  It is just provided to help identify the entity completing the W-9 when the payer won’t be familiar with the “legal” name used on Line 1.

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.

 

Are you at risk of IRS backup withholding penalties?

The potential for IRS backup withholding penalties should not be ignored!  They are assessed by the IRS at 24% of everything you have paid to a vendor if you do not follow IRS requirements.  For example, if you paid a vendor $1 million and the proper taxes were not withheld, the backup withholding penalty assessed to your company would be $240,000.  The IRS would then assess additional penalties and interest for the failure to withhold and deposit taxes by the due date.   And that would be for just one vendor!

In July of 2019, the IRS also increased its enforcement in this area by forming the Backup Withholding Enforcement Unit.  This unit looks for differences between backup withholding reported in Box 4 on 1099 forms and the amounts reported on Form 945 as well as other discrepancies. The IRS is getting serious about backup withholding. In 2019 alone the IRS issued $6.2 billion in nonreturn penalties.

What is backup withholding?

Under certain circumstances, a company making payments in the normal course of their business to a U.S. vendor will be required to withhold 24% of all payments made to the vendor and remit the amounts withheld to the IRS. This is called “backup withholding”. The main trigger for backup withholding is when a company does not obtain the vendor’s TIN (Taxpayer Identification Number) before payment.  A TIN is typically either the vendor’s Social Security Number or Employer Identification Number.  Most companies use Form W-9 to obtain the TIN from their vendors.  The TIN is then included on 1099 forms required to be filed with the IRS at the end of the year.

The primary reason the IRS requires backup withholding is to ensure that all 1099 forms include a TIN.  This allows the IRS to match the payments reported on the 1099 forms with the income reported by the vendors on their tax returns.  The IRS uses this payment information to verify that vendors report all the income they have earned and pay the correct amount of income tax.  By requiring 24% to be withheld the IRS ensures that any tax is paid in advance if a TIN is not provided.  This ensures that the IRS collects the tax owed.  It puts the ball in the vendor’s court to go to back to the IRS and get any overpayment refunded.

The solution!

Get a correct and complete W-9 form from every vendor before making a payment.  It’s as easy as that to avoid most backup withholding requirements!

Do you have a process in place to ensure that you have a correct and complete W-9 form from each vendor before payment?  That is one of the primary reasons we created W9manager.  W9manager connects directly to your accounting system and captures every vendor as created.  A W-9 request is then automatically sent out to each vendor with four additional reminders. The vendor uses our guided, step-by-step process to help them submit a correct and complete W-9 form.  And you can see the W-9 status for every one of your vendors at any time.  With plans starting at $69/year for 75 W-9 requests, W9manager is affordable for any size company.  Don’t risk paying 24% in backup withholding penalties!

What payments are subject to backup withholding?

Backup withholding can apply to most kinds of payments reported on Forms 1099 and W-2G, including:

    • Interest payments (Form 1099-INT)
    • Dividends (Form 1099-DIV)
    • Payment Card and Third Party Network Transactions (Form 1099-K)
    • Patronage dividends, but only if at least half the payment is in money (Form 1099-PATR)
    • Rents, profits, or other gains (Form 1099-MISC)
    • Commissions, fees, or other payments for work you do as an independent contractor (Form 1099-NEC)
    • Payments by brokers/barter exchanges (Form 1099-B)
    • Payments by fishing boat operators, but only the part that is in money and that represents a share of the proceeds of the catch (Form 1099-MISC)
    • Royalty payments (Form 1099-MISC)
    • Gambling winnings (Form W-2G) may also be subject to backup withholding.
    • Original issue discount reportable on (Form 1099-OID), Original Issue Discount, if the payment is in cash
    • Certain Government Payments, Form 1099-G

What payments are excluded from backup withholding?

Payments that are excluded from backup withholding include real estate transactions, foreclosures and abandonments, cancelled debts, distributions from Archer MSAs, long-term care benefits, distributions from any retirement account, distributions from an employee stock ownership plan, fish purchases for cash, unemployment  compensation, state or local income tax refunds, and qualified tuition program earnings.

What specific situations require backup withholding?

Payments made will be subject to backup withholding if:

1. A TIN is not provided to the requester,

2. The TIN is not certified (signed) when required (see the Part II of the W-9 instructions, page 3 for details),

3. The IRS tells the requester that an incorrect TIN was furnished.

4. The IRS tells the entity or individual receiving the payment that they are subject to backup withholding because they did not report all their interest and dividends on their tax return (for reportable interest and dividends only)

or

5. The entity or individual does not certify to the requester that they are not subject to backup withholding under 4 above (for reportable interest and dividend accounts opened after 1983 only).

Exempt payees

Certain payees and payments are exempt from backup withholding. See Exempt payee codes on page 3 of Form W-9 and the separate  Instructions for the Requester of Form W-9 for more information.  Generally, individuals (including sole proprietors) are not exempt from backup withholding.

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.

Top 5 mistakes made on W-9 forms

I’ve been a CPA for over 20 years now and have seen mistakes on W-9 forms every one of those years.  It seems like a simple form at first glance, but the W-9 form itself has 6 pages of instructions with almost 6,000 words.  Behind those condensed instructions on the W-9 form is a massive set of IRS tax code regulations.  Helping vendors and independent contractors create a correct and complete W-9 form is one of the reasons we started W9manager.

#5 – The name on line 1 of the W-9 form is blank

At times vendors can become confused between the names on line 1 and line 2.  They can mistakenly fill in only the business name on line 2 and leave line 1 blank.  Line 1 is the legal name that the business or individual uses on their federal tax return and is required by the IRS.  It is imperative that the name on Line 1 and the taxpayer identification number (typically an EIN or SSN) given on the W-9 form match to the IRS’s records. This will ensure that the IRS can apply any 1099 information received to the correct taxpayer account.  If they don’t match, the IRS won’t have confidence in the information provided and will send an error notice back to the reporting company.  This could lead to a 24% deduction in the vendor’s payment moving forward to satisfy IRS backup withholding requirements.

When using our guided form in W9manager, the user is required to complete line 1.  It is a required field and the user cannot continue to the next section until complete.

#4 – The W-9 form is not signed

Not all W-9 forms are required to be signed, but the best practice is to require that all vendors sign them unless the company understands all the situations in which a signature is required.  Vendors send in W-9s that aren’t signed and the accounting department at the company receiving the W-9 doesn’t always check for this.

When using our guided process in W9manager, a signature can be required when a W-9 form is sent to your vendor. As an added benefit, one user can complete the W-9 form and then send it to another user to sign.

#3 – The tax classification is not checked

Another mistake we see is a W-9 form without any tax classification checked. Line 3 of the form requires that the person completing the form check the appropriate box for the federal tax classification of the entity or person noted on line 1. This helps the company making the payment to the vendor determine if the payment is reportable on a 1099 form. Without this information, the company will have to assume a 1099 is required for all reportable payments made to the vendor. They won’t be able to exclude entities, like corporations, that are often exempt from receiving 1099s.

The first step users must do when creating a W-9 form in W9manager is to select their tax classification. They are not able to move to the next step without selecting a valid option.

#2 – Disregarded entity used on line 1 of the W-9 form

One of the most misunderstood concepts of the W-9 form is a disregarded entity. And consequently, because companies don’t understand this concept, listing the disregarded entity on line 1 is one of the biggest mistakes made on W-9 forms. When the disregarded entity name and TIN is then reported on a 1099 it can lead to the reporting company receiving a large number of CP2100 notices from the IRS.  These notices require the company to request a new corrected W-9 form from their vendor or start backup withholding 24% on the vendor’s future payments.

A disregarded entity is an entity that the IRS “disregards” for tax purposes or completely ignores. The IRS looks to the owner of the entity and all the tax liability flows to the owner of the entity. The best example is an LLC that is owned by one individual. The IRS “disregards” the LLC and requires that the individual owner’s information be provided on the W-9 form. For more information on disregarded entities, see our blog article, What is a Disregarded Entity?

When creating an electronic W-9 on W9manager users work through a multistep process to determine if they are a single-member LLC.  If they determine that this is the case, W9manager directs them to use the owner of the LLC on the W-9 form.  This process helps to reduce the number of disregarded entities listed on line 1.

W-9 form mistake #1 – The type of limited liability company is not provided

The number one mistake we have seen vendors make on a W-9 forms is forgetting to include the type of LLC. This is critical as it determines whether the LLC can be treated like a C or S corporation for 1099 reporting purposes. Most payments made to C or S corporations are not required to be reported to the IRS on a 1099.   However, payments made to LLCs that are partnerships or owned by an individual person are often reported.

One of the steps that users are guided through when completing a W-9 on W9manager is to select the type of LLC that they have. We ask them if they have filled out Form 2253 or 8832 with the IRS to be taxed as an S Corp or C Corp. If they select one of these options, we note their LLC tax classification as S or C respectively. If they have not filed either form, we then ask them if they are a single or multi-member LLC.  Multi-member LLCs are treated as a partnership and single-member LLCs are asked to use the owner’s information.

Additional References

For additional help, see the Form W-9 and instructions.

Use W9manager’s guided process to create your W-9.  It’s always free!

W9manager.comIn conclusion, we feel that all of the top 5 mistakes made on W-9 forms can be avoided when creating a W-9 form using W9manager. Use W9manager’s guided step-by-step process to help create the most correct and complete W-9 form.   It is always free to create and send your W-9 form.  W9manager is not just another blank PDF form site.  Every step of the way has contextual help buttons tailored to your specific circumstance.  The W-9 form is then electronically signed and sent securely sent to the requester.

You can then store your W-9 form centrally using W9manager.  Log into your account later and send it as needed.  If you need to create multiple W-9s for more than one company or individual, W9manager allows you to create multiple companies to manage them separately.  Finally, you can also use your mobile phone to send your W-9 from anywhere, to anyone, at any time.

Create and send your W-9 form with W9manager today!

 

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.