IRS Crack Down on 1099 Compliance

A client recently faced a harsh wake-up call: a $50,000 tax bill and an additional $30,000 in penalties and interest from the IRS. It can absolutely happen to you. The issue? They hadn’t collected the landlord's EIN for a US-based office (landlord is also a US entity), which led the IRS to determine that the client should have performed backup withholding on the large rent payments at 24%... do the math… Oh, and the IRS sent the notice 2 years later +interest +penalties = close the US Budget Gap.

The client had, in fact, sent out a 1099 as required, but because the EIN was missing, the IRS flagged this vendor as subject to backup withholding. Perhaps they had sent a letter in the prior year putting the company on notice that they should begin backup withholding or get the EIN, or maybe it was never received. In either case, backup withholding is not meant for good actors based in the US.? The 1099 form is informational, it is meant to help the IRS check the income tax filings of the recipients (the vendors you pay), it is the recipient who should report its income and pay taxes on that income. The IRS charge is for years prior, all parties have filed and paid their taxes – what is the issue? Seems like a misunderstanding, a problem caused by a technicality.

Dealing With IRS

To try and remedy the issue, we obtained the landlord’s EIN and filed corrected 1099 forms and sent them to the IRS agent. The IRS response was that our efforts weren’t enough – they wanted proof that we had the EIN before the original 1099 was due (mind blowing) or that the landlord had to sign a special form testifying to receiving the payments (Form 4669). Communications are done via fax and snail mail, once caught in their sights – you feel stuck in a maze where the walls are closing in. Sounds scary and overwhelming? It is. This client’s story is unfortunately becoming more common as the IRS ramps up enforcement of tax information reporting and backup withholding.

Why the IRS is Targeting 1099 Reporting and Backup Withholding

The IRS’s renewed focus on 1099 compliance and withholding is not just a routine audit threat—it’s part of a recent strategy to narrow the tax gap (difference between taxes owed and taxes paid) and improve reporting accuracy. According to a 2021 foreshadowing article from Mayer Brown, the IRS was planning to significantly step up its efforts in examinations of 1099 Forms, potential backup withholding obligations, and vendor on-boarding and reporting procedures. Mayer Brown wrote: “To the extent that a Form W-9 or Form W-8 is incomplete or insufficient in any regard, the IRS may consider such account holder as undocumented, even if the omission is immaterial to some. Failure to appropriately on-board and document an institution’s? account holders may result in underwithholding exposure.” So being “undocumented” is not okay with the IRS, they didn’t get the fax memo (tax humor).

What is Backup Withholding

So whereas many ignored 1099 filing requirements previously, a more rigorous approach is now needed. But where do you get the information needed to fill out 1099 forms? How do you determine if you have to withhold taxes from vendor payments? Form W-9 helps businesses obtain information needed for 1099 forms if the vendor is US based, but it also helps to determine if backup withholding is needed.? A W8 form is used for foreign vendors and you must make sure nothing on the form suggests they have a US presence. For more information see my other article on 1099 forms.

Backup withholding is required if (a) the vendor does not provide a TIN on form W9, or if the IRS notifies you that the (b) TIN provided is incorrect, or (c) the vendor did not report all income, or (d) the vendor failed to certify that he is exempt from backup withholding on his W9 form.? The current withholding tax rate is 24% - this amount must be held back from the payment you are making to the vendor and must be remitted to the IRS. If not, they will come after you for it and you will have to pay it out of pocket (see story above). Businesses must report and remit any amounts withheld using Form 945, "Annual Return of Withheld Federal Income Tax."

Common Triggers for IRS Scrutiny

1. Missing EINs or TINs: This is the primary cause of 1099 errors. If you make payments without obtaining the correct TIN, you’re setting yourself up for automatic backup withholding requirements.
2. Mismatched EINs/TINs: Even when you collect a TIN, if it doesn’t match the IRS database or if the name you have on the 1099 doesn’t match IRS records for that TIN (often due to typos or incorrect submissions), it’s treated as noncompliant, triggering the same issues.
3. Foreign Vendors Without Form W-8BEN: Payments to non-U.S. vendors also need proper documentation. Without a valid W-8BEN, such payments can become subject to 30% withholding under FATCA regulations.

How to Avoid Penalties and Ensure Compliance

The key to a successful 1099 filing process is preparation. With proper documentation and consistent practices, businesses can minimize the risk of non-compliance. Here’s a step-by-step guide to get ahead of the problem:

1. Collect Form W-9 for All U.S. Vendors BEFORE Making Payments: Before issuing any payment, ensure that you have a completed W-9 form on file for every U.S. vendor. This form provides the vendor’s TIN, entity type, and certification that they are not subject to backup withholding.
2. Require W-8BEN Forms from Foreign Vendors: For foreign vendors, obtain a valid W-8BEN form to certify their foreign status and potentially claim a reduced withholding rate under applicable tax treaties.
3. Perform TIN Matching Before Issuing 1099s: Use the IRS’s TIN Matching Program to verify that the TINs you’ve collected are correct and correspond to the vendor’s name as registered with the IRS. This step helps identify mismatches early and avoids potential penalties. Most 1099 software allow this for an extra fee.
4. Maintain a Robust Documentation System: Store all forms systematically, whether digitally or in hard copy. Implement consistent naming conventions and update files annually to ensure that information is accurate and up-to-date.
5. Be Proactive with Compliance Reviews: Regularly review your 1099 processes to identify gaps. Perform annual audits to ensure that you have all required forms, matched TINs, and accurate classifications of vendors BEFORE year-end. Right now (September) is a great time to start audit your records and get the missing W9s.

Don’t wait until it’s too late—protect your business by ensuring that every TIN is on file, send out all 1099s due, and don’t ignore IRS letters.