Generally, under Internal Revenue Code 3406(a)(1)(A), when a payer of US source income fails to collect a US tax identification number (TIN) in the manner required for the type of payment being made, 24 percent backup withholding is applicable at time of payment. Filers are required to remit those amounts to the IRS and file Form 1099 reflecting the withheld amounts in Box 4.
In the past, if a filer submitted Forms 1099 with missing or obviously invalid TINs (e.g., sequentially numbered TINs, TINs containing all of one digit, etc.), the filer could expect to receive a B-notice from the IRS. The notice triggered a requirement to request the TIN from the recipient, and if one was not secured within the regulatory timeframe, backup withholding was required on all future payments until a properly completed Form W-9 was secured.
Subsequently, filers would also receive proposed 972CG penalties from the IRS for filing a return with a missing or obviously invalid TIN, which triggers another regulatory process with the government.
Now, filers have another issue to be concerned with. The IRS announced that beginning in July, the Cincinnati enforcement division will launch a focused audit program to analyze information reporting consistencies and mismatches, and contact filers when discrepancies are found on Form 945 and/or Forms 1099. Examples of discrepancies include payers who file Forms 1099 reflecting backup withholding but then do not also file a corresponding Form 945. The program is also focused on payers who file Forms 1099 with missing or obviously invalid TINs and where there is no backup withholding is reflected in Box 4.
Typically, enforcement of Chapter 61 issues occurs as a result of an employment tax audit, so this initiative is particularly interesting because it is focused through a centralized team out of the Cincinnati campus.
At the American Payroll Association’s Capital Summit in Washington in late March, Daniel Lauer, IRS director of examination operations and specialty tax, told Tax Notes, “There’s so many compliance challenges. Withholding is such an important part of tax administration. If people don’t withhold and then they report, then we have to spend collection resources a lot of [the] time, [set up] payment installment agreements, and other things in the collection arena. So it’s a little bit of a short term loss for a long-term gain.” Although this program does require some effort on the part of IRS, the agency is optimistic that it will reduce the number of instances and minimize the problem in the long term. “It’ll evolve over time,” Lauer said. “We’re going to test and learn.”
The IRS is working smarter, not harder, for these penalties. It’s pretty easy to spot a compliance issue when a payer files a Form 1099 with a missing or obviously invalid TIN and there is no withholding reflected in Box 4 of that same form. This is information the IRS has at its fingertips and has had for years.
Payers who fail to withhold at time of payment to a recipient with a missing or obviously invalid TIN become liable for the withholding tax that should have been imposed. This can become extremely expensive very quickly. Here is an example:
Bank A established a brokerage account for Recipient C, who failed to provide a valid Form W-9 when the account was established. Bank A paid Recipient C a total of $20,000 in dividend income throughout the calendar year but did not impose backup withholding. Bank A filed Form 1099-DIV with the IRS, reflecting the missing TIN and no backup withholding in Box 4.
The IRS fined Bank A for failing to withhold when required: $20,000 x 24% = $4,800. Bank A was also subjected to penalties and interest for failing to deposit the withholding by the due date; the max of 10 percent was applied: $4,800 x 10% = $480. Bank A was also subjected to information return penalties for filing a Form 1099-DIV with erroneous information: $270. For failure to withhold on a single recipient, Bank A had to pay the IRS $5,550.
Payers should be considering ways to streamline this process to ensure that they are in compliance. Here are Sovos’s top four recommendations:
- Collect tax information when required. Ensure that policies and procedures reflect the requirement to collect a TIN in the manner required for the payment. Generally, backup withholdable payments require a valid Form W-9 from the recipient on or before time of payment.
- Impose backup withholding immediately if the information is not secured, before any payments are made. When payments of income are made to US persons who fail to provide a TIN, there is no grace period for withholding. Withholding is required at time of the very first payment, not on future payments, and refunds are not allowed just because a W-9 is submitted later in the calendar year.
- Invest in technology to automate the remittance, reconciliation and reporting process to the IRS. Withholding liabilities, payments made to the IRS and the backup withholding amounts reported on Forms 1099 must match. Otherwise, additional taxes could be due (with penalty for late remittance).
- Build audit reports to identify 1099s that contain missing or obviously invalid TINs and no corresponding withholding before you file! While you can’t go backward to resolve the withholding compliance issue in this scenario, you can at least secure updated TINs and file corrected 1099s to minimize the B-notice and/or 972CG penalty.
Discover how Sovos enables customers to deal with changing 1099 regulations automatically.