Tax Identity Management 101

The Comprehensive Guide to Understanding and Complying with IRS TIN Matching Requirements

What is Tax Identity Management?

The meaning of tax identity management varies depending on the type of industry you work in and the role you have within your organization. For those responsible for tax information reporting (TIR) in their organization, it means ensuring you are doing business with legitimate individuals and businesses by collecting and reporting correct tax identity information to government agencies. The two most common data elements tax regulators care about are tax identification numbers (TINs) and names. The combination of these two things is what governments use to 1) ensure the individuals and businesses being reported are in their database correctly and 2) ensure they are able to reconcile what’s being reported on 1099 and annual income tax returns (i.e., Form 1040, etc.) to determine proper taxation on income. At the surface level, tax identity management may seem easy for organizations to get right but there are many nuances that make it rather difficult to manage.

Why do governments care about Tax Identity Management?

Governments care about tax identity management for one reason, revenue. According to a report by the Treasury Inspector General For Tax Administration (TIGTA), incorrect or missing tax identity information via Form 1099 returns has led to a $9B tax gap with the IRS. The TIGTA recommended enforcement of backup withholding in order to narrow that tax gap. Backup withholding, simply put, requires payors to withhold 24 percent of future payments that are made to recipients with incorrect tax identity information.

This allows the IRS to collect tax money proactively—as the payment happens, rather than relying on a reactive approach of trying to track down the correct recipient and collect the taxes owed.

What happens if an organization files incorrect tax identity information?

When an organization files incorrect tax identity information on a Form 1099 return that is subject to backup withholding, the IRS is unable to easily reconcile that information with the corresponding taxpayers annual return (i.e., 1040, etc.) to ensure proper tax has been collected. If they are eventually able to reconcile the 1099 and annual income tax returns, it is through a very manual and time-consuming process. This is why there is strict IRS enforcement. When an organization incorrectly reports tax identity information, the IRS takes action by:

1

Issuing Notice CP2100

2

Assessing Notice 972CG

3

Enforcing backup withholding by issuing penalties

Payments and forms subject to backup withholding:

IRS Notice CP2100 (“B” Notice)?

The CP2100 is an IRS notice notifying the payor of all records they filed for a specific calendar year with either missing or incorrect tax identity information that would then make those records subject to backup withholding on future payments. The CP2100 is often referred to as a “B” notice, where the B stands for backup withholding. The “B” Notice letter from the IRS requires that the payor solicits the recipients appearing on the notice for updated or corrected tax identity information. If the payee does not respond to the solicitation within 30 days of the payor receiving the IRS Notice, 24 percent backup withholding needs to be applied by the payor on future payments to the payee.

What is Backup Withholding and how is it enforced?

As mentioned previously, backup withholding exists to ensure the government receives the taxes due on all appropriate income. Backup withholding is required to be applied by the payor on payments made to the recipient when 1) there is a missing TIN when issuing payment or 2) they have been notified through Notice CP2100 that the tax identity information previously filed was incorrect and has not been corrected since the erroneous 1099 was filed.

The IRS backup withholding rate is 24 percent. This means if an organization is making a $10,000 payment to an individual for services rendered that has a missing TIN or an invalid TIN as notified by the IRS, that the actual payment to the individual should be $7,600 and the remaining $2,400 is withheld and remitted or paid directly to the IRS.

As for enforcement of backup withholding, the IRS has recently started to crack down on audits—specifically Tier 1 audits—for organizations filing Form 1099s that are subject to backup withholding that have missing or invalid TINs and do not have withholding amounts reflected in Box 4 (Federal Income Tax Withheld) of that same Form 1099.

This increase in IRS enforcement stemmed from a series of TIGTA reports. In addition to the $9B backup withholding tax gap due to payors filing 1099 returns with missing or incorrect TINs, TIGTA also found in that there is an additional $1.9B tax gap where backup withholding is not being reported or is underreported on Form 945 when comparing to Form 1099s filed. Form 945 shows amounts actually remitted to the government, so this means while the payor is telling the recipient and government that they are backup withholding on Form 1099, it is not actually being remitted to the government via Form 945. Meaning the government may not have received the taxes it’s owed. In the previous scenario where the individual was to have $2,400 withheld, the correct way of reporting and remitting to the IRS is to have that amount on both Box 4 of Form 1099 and on Form 945.

The TIGTA found the following scenarios contribute the most to the overall tax gap:

Organizations that are not accurately backup withholding on payments are not only subject to these Tier 1 audits by the IRS, but may also be subject to penalties including:

What is Notice 972CG (“P” Notice)?

IRS Notice 972CG is a proposed civil penalty for information filed late, filed on incorrect media, filed with missing or incorrect TINs, or any combination of those three. Notice 972CG is often referred to as a “P” Notice because of the penalty associated with the notice. For penalties on a “P” Notice for missing or incorrect TINs on backup withholdable 1099s, it is highly likely that the payor would have received a “B” Notice that would have required them to solicit recipients for correct tax identity information prior to receiving a “P” Notice. In this case, organizations can utilize the solicitations mailed in the “B” Notice process when applying for penalty abatement.

However, the IRS does not always send a “B” Notice prior to a “P” Notice, because some 1099s are not backup withholdable. These 1099s first appear on the “P” Notice and a solicitation to the recipients that are appearing on the “P” Notice. Penalties associated with missing or incorrect tax identity information filed with the IRS can currently cost an organization $290 per return filed with a max penalty of up to $3,532,500. Other penalties associated with the original tax information filing can be included on a “P” Notice, like late filings or using the incorrect media for filing—but those fall outside of tax identity management.

How does an organization mitigate filing incorrect tax identity information?

Organizations can take a proactive approach to tax identity management and reduce the amount of Form 1099s filed to the IRS with incorrect information, therefore reducing the number of returns appearing on “B” and “P” Notices. A reduction in “B” and “P” Notices not only means reducing audit exposure and unexpected penalties, but it can also increase operational efficiency. Organizations spend an immense amount of time managing “B” and “P” Notice processing. It takes countless hours manually reconciling “B” and “P” Notice records with source system information, soliciting payees to gain corrected tax identity information, tracking backup withholding statuses and putting together penalty abatements.

A proactive approach consists of checking tax identity statuses during vendor or customer onboarding to ensure tax ID information is accurate and that the businesses or individuals are legitimate before issuing payments. This eliminates the majority of incorrect tax identity information from being filed with the IRS. Another proactive approach is to administer ongoing bulk TIN checks to account for changes in names and TINs that may occur post-onboarding. This allows an organization to check TIN statuses with the IRS in mass before filing their 1099 returns, informing them on who to solicit for correct tax identity information prior to filing. It also lets them know their potential penalty exposure if they file with the IRS using information already on file.

How can Sovos help?

Sovos provides two methods for handling tax identity management. The first involves proactive measures to reduce errors and penalties altogether, which includes real-time TIN verficiations, bulk TIN matching and proactive solicitations. Sovos also provides a compliant approach to solicitation and response handling to ensure compliance with all IRS notice requirements.

Sovos’ Proactive Tax Identity Management Approach

The best defense is a good offense when it comes to tax identity management. Sovos offers three proactive tax identity management solutions that allow organizations to reduce or even eliminate filing missing or incorrect tax identity information to the IRS. Investing up front in your organization’s tax identity management process allows you to mitigate audit exposure and unexpected penalties while increasing operational efficiency. Sovos’ proactive tax identity managements solutions are:

Real-Time TIN Verifications validates tax identity information in real-time against the following databases through Sovos’ Tax Information Reporting Solution or directly through your organization’s onboarding or source system using XML web services.

IRS TIN Matching Database – verifies payee data against the IRS employer identification number and/or social security number database to ensure correct name/TIN combinations.
Office of Foreign Assets Control – checks against the Department of Treasury’s Office of Foreign Asset Control (OFAC) Specifically Designated National (SDN) list, so organizations can avoid making payments to known terrorists, drug traffickers, and organizations or individuals involved in known criminal enterprises.
Death Master File – checks an individual’s tax identity information against a list of Social Security numbers whose deaths have been reported to the Social Security Administration since 1980, so organizations can minimize fraudulent activity.

Bulk TIN Matching provides organizations the ability to submit their entire reportable database for verification against the IRS TIN Matching Database prior to filing tax information returns. This allows organizations to know which records have incorrect tax identity information and therefore who they should solicit for correct information prior to filing. Bulk TIN Matching also helps organizations understand what potential penalty exposure they have if they file with the IRS using information already on file.

Proactive Solicitations are helpful for organizations before filing with the IRS to help get ahead and fix tax identity information they know is incorrect due to administering a real-time TIN verification or bulk TIN matching. Sovos’ proactive solicitations include both the printing and mailing of Form W-9s to payees with incorrect tax identity information and can also include response handling for those who respond to the solicitation with updated information.

By proactively identifying and correcting inaccurate tax identity information before submitting to the IRS, organizations can avoid “B” Notices, financial penalties and the headaches of abatement and backup withholding altogether.

Sovos’ Compliant Tax Identity Management Approach

When errors do occur, Sovos offers reactive or compliant tax identity management solutions that give organizations control over their “B” and “P” Notice solicitations and response handling processes.

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