What the IRS Needs You to Know
The Internal Revenue Service (IRS) is primarily responsible for enforcing U.S. Tax laws and guaranteeing that tax levies are collected. There is an ongoing gap however, between tax revenue owed to the IRS and what the IRS collects. This gap, which has hovered at approximately $300 billion plus per year for the past decade, is known as the “tax gap”. The tax gap is caused by a variety of elements. For instance, some U.S. corporations and wealthy U.S. persons hide their assets and income in foreign bank accounts. There is another element that makes up the tax gap however, and that is where your organization steps into the picture.
Employers and other third parties provide the IRS with independent information about income received and taxes withheld on information returns (such as Forms W-2 and the Form 1099 series). The IRS then matches these information returns to filed tax returns. At this point, if necessary, the IRS contacts third party payers and payees for several purposes. These purposes include identifying persons who did not file returns, to resolve discrepancies between payer and payee records for those that did file returns, and to assess tax, interest, and penalties based on the information gathered.
Form 1099 reporting attracts the lion share of the IRS efforts. This is because the level of tax compliance associated with payments to independent contractors and non-employees associated with payments that should be reported on the Forms 1099 significantly lags the rate of compliance achieved by employees and reported on the W-2. The IRS is very interested in changing this reality. Because of recent IRS efforts, the total number of cases reviewed by the IRS climbed 10% between 2003 and 2007. Moreover, during the same period the IRS increased its discovery of under reporters by 210%.
The potential financial liability of penalty exposure is severe and can easily run into the millions of dollars, tens of millions of dollars or even hundreds of millions of dollars if you are a large enough filer. IRS imposed monetary assessments have surged a staggering 380% from 2003 to 2007. Perhaps even more shockingly, the increased monetary assessments reported by the IRS in the 2007 Data Book exclude interest and penalties – meaning under reporters faced tens of millions in additional costs for just the 2007 tax year. Needless to say the renewed emphasis on regulation that began in 2008 is all the more likely to increase IRS enforcement efforts.
Penalties You Might be Facing for Non-Compliance
The IRS builds the kind of case that will produce such huge sums of assessed penalties one-step at a time. For instance, the IRS may assess a $50 monetary penalty for every Form 1099 with errors. You need to pay attention to IRS terminology here. For example, the term “error”, from the IRS examiner’s point of view, may mean something very different from what you perceive of as an “error”. In the IRS’ eyes, an “error” can be a payee Taxpayer Identification Number that you filed in good faith but which the IRS says does not match the TIN in U.S. government files for the named payee. Moreover, there is a penalty for every Form 1099 you should have filed with the IRS but failed to and there is a penalty for every Form 1099 filed without a Taxpayer Identification Number. On top of all these potential errors, there are corresponding $50 penalties for each payee statement that you failed to deliver or did so but with an error.
Now, from these initial steps, accumulated $50 penalties can rapidly double if IRS examiners find willful disregard of tax reporting requirements. Willful disregard is another one of those IRS terms you need to pay attention to; many of us think of Enron or Madoff style fraud when they think of such a term. In reality, the IRS considers you to have met a willful disregard level violation of conduct just through behaviors such as a lack of compliance policies and procedures, a lack of training, a lack of internal controls and documentation, or even inaction when there are indications that problems exist.
Backup Withholding Basics
In addition to facing penalties, the IRS also expects third party reporters, such as your organization, to help enforce the penalty framework. This includes the requirement to backup withhold or remit to the IRS 28% of the total of all payments from which U.S. backup tax withholding is due. Backup withholding applies to all payments, reportable on certain Forms 1099, made without having first obtained the U.S. Taxpayer Identification Number of the payee. In addition, backup withholding also is required for any payments made after a payee has been listed on an IRS B-Notice 2100/2100A, if certain specific documentation is not subsequently obtained from the payee within a strict time limit set by the income tax regulations. This IRS Notice serves warning that the payee TIN used on a Form 1099 filed by your organization did not match the TIN in government files for the named payee. If this were not enough, two other types of backup withholding also exist in the regulations.
Back up withholding is another area where a failure by your organization can be costly. If your organization does not back up withhold then the IRS can hold it liable for the 28% required by law to have been withheld from payments to reportable individuals or entities. If backup tax withholding was not withheld from the payee’s check at the time of payment, then your organization will have to pay it directly.
What this Means for You
Information reporting is not going away, far from it. Form 1099 compliance is a key component of IRS compliance efforts, including the audit process. In addition, auditors and examiners look at more than the Forms 1099 filed; they look at each and every payment made. They have a simple goal, to locate those payments that should have been reported but were not.
Your participation is key to making this process work. It is assumed that you know the law and are working hard to help the IRS reach its regulatory goals. If your organization is failing to document its activities, or if your organization lacks the policies and procedures needed to track its compliance efforts, the IRS assumption is that the organization failed to follow the law. Thus, your organization has to know the law, follow the law and stay on top of the law; which in the tax world is not only complicated and ever changing but goes beyond the Federal level to includes state and local level regulatory bodies with their own unique tax laws. This means your organization has to constantly train and retrain its employees, even at different level and departments or in various geographic locations, so they can help your organization follow IRS regulatory requirements. This is where we can help.
