Every 1099 form transmitted to the IRS has the potential to become a costly penalty. For organizations experiencing rapid growth, an influx of new contractors, distributors or service providers can be exciting, but fraught with risk as tax season approaches. Regardless of your business model and how you classify payments to your service providers, having correct tax identification numbers (TINs) is a critical component for accurate tax reporting.
The most common cause of 1099 reporting errors is mismatches between recipient names with TINs. If the name and TIN reported on a 1099 form do not match what’s in the IRS database, an error will occur. Errors can lead to incorrect filing penalties and trigger withholding obligations for your organization.
These errors from the IRS are called B notices and require payors to withhold 24 percent backup withholding tax from the gross amount of payments until a new Form W-9 is obtained. Companies remit those amounts to the IRS and file annual reconciliation returns. Name and TIN mismatch errors can also result in expensive IRS information reporting penalties, amounting to $270 per form, with a cap of about $3.3 million for large businesses.
Penalties for inaccurate data are not the only issue for organizations focused on rapid growth. The additional time and expense of payee outreach and corrections are extremely costly as well.
Luckily much of this can be avoided with a simple automated check during the onboarding process.
What is TIN matching?
The IRS gives payors of certain types of transactions the ability to proactively prevent these errors by performing name and TIN matches according to their database. Matching names and TINs before filing 1099 forms enables payors to take action to correct the information before a filing error occurs. There are two types of TIN matching offered by IRS:
- Bulk TIN matching matches many records against the IRS’s database at one time. The payor uploads .txt files composed of up to 100,000 name/TIN combinations and receives a response from IRS within 24 hours on the status of the uploaded records.
- Interactive TIN matching enables payors to quickly verify that information is correct, usually for individual or small groups of forms. The payor can submit up to 25 name/TIN combinations at a time, and the IRS system responds within seconds.
While bulk TIN matching is useful for checking records just before or during reporting season, interactive TIN matching can be incorporated into upstream onboarding processes prior to reporting season. With it, payors can check for name/TIN consistency during the customer and vendor onboarding process, meaning they can correct errors one at a time rather than getting hit with a load of bulk-matching corrections.
TIN matching form eligibility
Not all 1099 forms are eligible for TIN matching. But there are a number of forms common to fast-growth gig economy and referral marketing organizations that are eligible, which means they are also subject to mismatch penalty reporting and backup withholding. They include:
- Merchant Card Third Party Network Payments (1099-K)
- Miscellaneous Income (1099-MISC)
- Non-Employee Compensation (1099-NEC)
Those familiar with 1099-K merchant payment reporting have seen the rapid and dynamic changes with this form. From expansion of reporting obligations with lower payment thresholds, to many states like CA, IL, FL and VA beginning to adopt their own rules, this form continues to expand in breadth and complexity.
The 1099-NEC is a new form for tax year 2020 that will replace Form 1099-MISC box 7 as the new form for reporting nonemployee compensation. 1099-MISC is the form for reporting rents, royalties and other types of ordinary income. And as a result of the removal of the box 7 for nonemployee compensation, the IRS overhauled that form for 2020 reporting too.
How the IRS handles TIN matching
The IRS requires an e-services ID for TIN matching issued through IRS.gov, and obtaining one isn’t a simple process. For some organizations, there is inherent risk in even obtaining and using a TIN matching ID.
On December 10, 2017, the IRS changed the registration process for acquiring a TIN matching ID. Both new and existing users now have to register (or re-register) and provide additional information, including a personal mobile phone number and one of the following financial account numbers: credit card, mortgage loan, home equity line of credit or auto loan.
The log-in process also changed to require two-factor authentication, which sends a security code to a personal mobile device. That code is necessary for login. As such, the TIN matching ID is associated with the individual employee who enters personal information, not with the payor company itself.
These new, more rigid access rules present potential problems for organizations that use TIN matching services:
- Employees now have to provide personal information to the IRS to conduct TIN matching, which they might be hesitant or unwilling to do. This inherently involves a security risk.
- The two-factor authentication process limits the number of people within an organization who are able to log into the TIN matching system. As a result, a payor might not be able to proactively TIN match across the organization during vendor or customer onboarding, which eliminates one of the major advantages of interactive TIN matching.
How Sovos can solve ID issues
As a third-party reporting solution provider, Sovos can solve TIN matching issues for payors. Sovos clients access the IRS TIN matching system through a Sovos ID eliminating the need to obtain one of their own.
With Sovos acting as a third-party provider, payors can access the IRS TIN matching system without requiring employees to provide the IRS with their own personal information. A third-party ID also eliminates problems stemming from two-factor authentication. Using a Sovos ID, an organization’s employees no longer need to use two-factor authentication to enter the TIN matching system.
As such, organizations can scale interactive TIN matching to as many employees as necessary at any time. The ability to scale means that payors can TIN match during customer and vendor onboarding, thereby eliminating reporting errors before they occur. Only with third-party ID access can organizations reap the full benefits of interactive TIN matching. And only Sovos offers third-party ID access as part of our suite of 1099 reporting solutions.
TIN matching is essential to eliminate errors in the 1099 reporting process, but fully realizing the advantages of interactive TIN matching requires some help.
In addition to TIN matching, state reporting can cause major challenges for gig economy and referral marketing companies. Florida recently changed their reporting regulations to require 1099-K filing for the first time. And other states like Maryland have legislation in the works.
Download our state reporting webinar for free to learn more about state reporting changes and how to safeguard your business.