Another Backup Withholding Story

 

We talked not too long ago about backup withholding.

What is it?

Think Forms 1099 and you are mostly there.

The IRS wants reporting for many types of payments, such as:

·       Interest

·       Dividends

·       Rents

·       Royalties

·       Commissions and fees

·       Gambling winnings

·       Gig income

Reporting requires an identification number, and the common identification number for an individual is a social security number.

The IRS wants to know that whoever is being paid will report the income. The payor starts the virtuous cycle by reporting the payment to the IRS. It also means that – if the payee does not provide the payor with an identification number - the payor is required to withhold and remit taxes on behalf of the payee.

You want to know how this happens … a lot?

Pay someone in cash.

There is a reason you are paying someone in cash, and that reason is that you probably have no intention of reporting the payment – as a W-2, as a 1099, as anything – to anyone.

It is all fun and games until the IRS shows up. Then it can be crippling.

I had the following bright shiny drop into my office recently:     

    

The client filed the 1099 and also responded to the first IRS notice.

It could have gone better.

That 24% is backup withholding, and I am the tax Merlin that is supposed to “take care of” this. Yay me.

This case was not too bad, as it involved a single payee.

How did it happen?

The client issued a 1099 to someone without including a social security number. They filled-in “do not know” or “unknown” in the box for the social security number.

Sigh.

Sometimes you do not know what you do not know.

Here is a question, and I am being candid: would I send in a 1099 to the IRS if I did not have the payee’s social security number?

Oh, I understand the ropes. I am supposed to send a 1099 if I pay someone more than $600 for the performance of services and yada yada yada. If I don’t, I can be subject to a failure to file penalty (likely $310). There is also a failure to provide penalty (likely $310 again). I suppose the IRS could still go after me for the backup withholding, but that is not a given.

Let me see: looks like alternative one is a $620 given and alternative two is a $38,245 given.

I am not saying, I am just saying.

Back to our bright shiny.

What to do?

I mentioned that the payment went to one person.

What if we obtained an affidavit from that person attesting that they reported the payment on their tax return? Would that get the IRS to back down?

It happens enough that the IRS has a specific form for it.               

We filled in the above form and are having the client send it to the payee. We are fortunate, as they have a continuing and friendly relationship. She will sign, date, and return the form. We will then attach a transmittal (Form 4670) and send the combo to the IRS. The combo is considered a penalty abatement request, and I am expecting abatement.

Is it a panacea?

Nope, and it may not work in many common situations, such as:

(1)  One never obtained payee contact information.

(2)  A one-off transaction. One did not do business with the payee either before or since.

(3)  The payee moved, and one does not know how to contact him/her.

(4)  There are multiple payees. This could range from a nightmare to an impossibility.

(5)  The payee does not want to help, for whatever reason.

Is there a takeaway from this harrowing tale?

Think of this area of tax as safe:sorry. Obtain identification numbers (think Form W-9) before cutting someone their first check. ID numbers are not required for corporations (such as the utility company or Verizon), but one is almost certainly required for personal services (such as gig work). I suppose it could get testy if the payee feels strongly about seemingly never-ending tax reporting, but what are you supposed to do?

Better to vent that frustration up front rather than receive a backup withholding notice for $38,245.

And wear out your CPA.

Backup Withholding On A Gig Worker

I am minding my own business when an IRS notice lands in my office. Here is a snip:

Question: is this bad?

Answer: it might be.

Let’s talk about it.

The IRS requires Form 1099-NEC be provided a nonemployee service provider paid over $600 over the course of a year. This is the tax form sent to self-employeds and gig workers.

The acronym “BWH” means backup withholding.

So, we are talking about withholding on nonemployees.

How can this be? Employee withholding is easy to understand: federal income tax, FICA, state income tax and whatnot. Anyone who is a W-2 has seen it – or is seeing it – every pay date. But there is no withholding on a nonemployee. A nonemployee is responsible for his/her own taxes. How do we even get here?

There are several ways. Let’s go through two.

Let’s say that I own a business called Galactic. Galactic hires someone to take care of our IT system. That someone is named Rick, and Rick does business as REM Consulting.

OK.

Rick does work. He sends an invoice for $750. Galactic pays him $750.

Here is our first way to backup withholding.

Rick immediately exceeded the $600 hurdle. He provided covered services, i.e., he is a gig worker. Galactic will send Rick a 1099-NEC at year-end. Presently, that 1099 is at $750. It will increase every time Rick does additional work.

Galactic needs some information from Rick to prepare that 1099: a name, an address, and a taxpayer identification number (TIN). I expect the name and address to be easy, as that would be on Rick’s business card or invoice. The TIN might not be so easy. A common TIN is a social security number. I guess Rick could provide Galactic his SSN, but then again, Rick might not be keen with passing-out his SSN all day every day.

Rick instead is thinking of making REM Consulting a single member LLC. Why? The default tax rule is to disregard a single member LLC as a separate entity. To the IRS, REM Consulting is just Rick (mind you, state rules may be different). Why bother, you wonder? Because REM Consulting can get its own employer identification number (EIN). If I were Rick, I would use that EIN instead of my SSN for all business purposes.

COMMENT: If you read the instructions, REM Consulting technically does not have to apply for an EIN until it has employees. That is true but beside the point. We automatically request an EIN for all new LLC’s – single member or not.

Back to the first way into backup withholding.

Galactic asks Rick for a TIN. Rick says “No.” Why? Because we need Rick to say “No” to continue our discussion.

Galactic is required to start backup withholding immediately, as Rick has already cleared the $600 floor. The withholding rate is 24%. Galactic will withhold $180 and send Rick a check for $570. Galactic will of course have to send that $180 to the IRS (it is withholding after all). Hopefully Rick relents and provides a TIN. If so, Galactic will include his TIN and withholding on the 1099-NEC, and Rick can get his withholding back when he files his personal return.

A second way is when the payor has the wrong TIN. Let’s say that Rick gave Galactic his EIN, but Galactic wrote it down incorrectly. Galactic and Rick are a year into their relationship, and everything is going well, except that Galactic receives a letter from the IRS saying that that Rick’s 1099-NEC is incorrect. The name and TIN do not match.

There is a short period of time allowed for Galactic to review its records and get with Rick if necessary. If the matter is resolved (someone wrote the TIN down incorrectly, for example), then Galactic corrects the matter going forward. That is that, and no backup withholding is required. Galactic does not even have to contact the IRS for permission.

However, say the matter is not resolved. Rick has no interest in helping. Galactic will have to start backup withholding on its next payment to Rick. Mind you, it can later stop withholding if Rick comes to his senses.

Withholding is a pain. There is additional accounting, then one must remit the money to the government and file additional tax returns. Every step has due dates and penalties for not meeting those dates.

Let’s say you receive that IRS notice and blow it off. After all, what is the worst the IRS can do, you ask.

Well, they can hold you responsible for the withholding.

But I didn’t withhold, you answer.

They don’t care. They want their money. You were supposed to withhold from Rick and remit. You chose not to withhold. You now have substitute liability and will have to reach into your own pocket and remit. Perhaps you can ask Rick for reimbursement, but you probably should not pack luggage for that trip.

A few more things about backup withholding:

• There is a form to provide your TIN (of course): Form W-9. It is extremely likely you filled one out when you started your job.
• You might be surprised how many different types of income are subject to backup: interest, dividends, rents and so on. It is not limited to gig income.
• A famous exception to backup is retirement income. Realistically, though, you won’t be able to even open an IRA account with the major players (Vanguard, Fidelity and so on) without providing a TIN upfront.
• It can apply to nonresident foreign nationals, although the withholding rate is different.
• The way to stop backup is to correct the situation that created it in the first place: that is, provide your TIN.

A difference between the two scenarios is when responsibility for withholding begins:

In scenario one, it begins with the first payment to Rick.

In scenario two, it begins more than a year later, upon receipt of a notice from the IRS.

Both scenarios can be bad, but scenario one especially so. At least scenario two is prospective (assuming you do not blow off the multiple notices the IRS will send).

Back to the start of this post. Which scenario do I have: scenario one or scenario two?

I do not know at this moment.

Let’s hope it is not bad. 

You Want Me To E-File Your Tax Return? Then Show Me Your ID.

There are times I wonder why I do what I do.

It is difficult enough to keep up with the barrage of tax developments, pronouncements, law changes, court decisions and what not. I do not practice in all areas, so there is some fence around this field, but it is still a fairly large field.

Then you have the IRS bureaucracy, which is becoming more unwieldy every year. It used to be that I could contact a local IRS person to help with a tax problem. After a while, one got to know the local IRS employees, and they got to know me. The IRS restructuring took away our local contacts. Practitioners now contact regional offices using an 866-telephone number. Wait times have been noticeably increasing over the last two or three years.  I gave up on a call this past Thursday as it approached an hour and a half.

Folks, this is a “back door” line for CPAs and attorneys. I can only imagine what the wait time is for the general line.

This past week I was reading Publication 1345 titled “Handbook for Authorized IRS e-file Providers of Individual Income Tax Returns.” I would not recommend it unless you are a serious insomniac.  I came across the following pearl:

In-Person Transaction

The ERO must inspect a valid government picture identification; compare picture to applicant; and record the name, social security number, address and date of birth. Verify that the name, social security number, address, date of birth and other personal information on record are consistent with the information provided through record checks with the applicable agency or institution or through credit bureaus or similar databases. For in-person transactions, the record checks with the applicable agency or institution or through credit bureaus or similar databases are optional.

Examples of government picture identification (ID) include a driver’s license, employer ID, school ID, state ID, military ID, national ID, voter ID, visa or passport. 

If there is a multi-year business relationship, you should identify and authenticate the taxpayer."

Huh?

Let’s translate. An ERO is an electronic return originator. That is fancy language for someone who is authorized to file returns electronically with the IRS. My firm for example is an ERO. That makes me an ERO.

The IRS is talking about me inspecting a “valid picture identification” and so on. And when am I supposed to do this?

The IRS starts off talking about electronic signatures on a tax return. Obviously if I file your return electronically, I cannot send your fresh-ink signature at the bottom of the form. I do require from you a release authorizing me to e-file your return. That release may have your fresh-ink signature, but that release stays with me. The IRS does not get a copy.

Is the IRS talking about the e-signature on the return I file for you? Or is the IRS talking about an electronic signature on the release I obtain from you before e-filing your return? There is a big difference, and I cannot tell what the IRS meant. I suspect the IRS is talking about electronic signatures on the release. For the most part most of my clients sign their release in ink, although many clients will either fax or PDF their release to me. I am presuming the fax or PDF does not constitute an electronic signature, but I do need the IRS to be more precise in its use of the language.

Then there are the few clients. You know the ones: the computer hyper-literate. These guys can write a ditty, put music and video to it and publish the whole thing on You Tube in the time you or I would draft an e-mail. These guys are going to cause me a problem, because they know enough to sign that release with an "electronic signature.”

Let’s say they do.

The IRS now wants me to:

(1)  Inspect a valid government picture identification.

I presume we are talking about a driver’s license. It is inconvenient, but it follows what the stockbrokers have done for years.

What am I supposed to do with the kids, though, if the kids are too young to drive? 

What if mom and/or dad live with the client? Where does this end?

(2)  Record the name, social security number, address and date of birth.

No problem. We already do that.

(3)  Verify that information through record checks with the applicable agency or institution or through credit bureaus or similar databases.

Are you kidding me?

That one angers me. There is a superstructure of self-serving – and obviously incompetent - government bureaucrats and they have to recruit a tax CPA in Cincinnati to do THEIR JOB? I tell you what I want in return: I want a government salary; government benefits; all the holidays, including the make-believe ones; 6 weeks of vacation; a retirement plan; union protection so that I cannot be fired, no matter how incompetent I am.

What if I have known you for years?

If there is a multi-year business relationship, you should identify and authenticate the taxpayer."

Seriously? And what does “authenticate” mean?

Good grief. It would be less work to let these people vote. Hire me to do your taxes, however, and I have to go all Kojak on you.

How have we gotten to this point?

It has to do with identity theft. It has become a top-tier issue for the IRS. They responded in turn with Publication 1345. I am trying to be fair, I truly am, but I see a few things the IRS could immediately do before making me their Barney Fife:

(1)  Review refunds to taxpayers with a different address from last year.

(2)  Review refunds to taxpayers with a different employer from last year.

(3)  Stop issuing multiple refund checks to the same address. For example, the IRS sent 655 refund checks to the same address in Lithuania.

And what tax crook in his/her right mind is going to hire a tax CPA to do their dirty work anyway? Somebody clue the IRS that is not how those people work.

Publication 1345 addresses only individual tax returns. Is the IRS going to extend this to business returns? Will I need to confirm corporate minutes to be certain that Tom N. Jerry is in fact the CEO of that corporation and authorized to sign the corporate return? Will I need in turn to background check Tom N. Jerry himself?

And where will the time come from to do all this? I am already swamped during busy season. Even if the above takes only 5 minutes per return, multiply the 5 minutes by hundreds of clients. The IRS could easily add at least another 40 or 50 hours to my individual tax practice, time that I do not have. How will I respond? I will extend more returns. I would have to. I will charge you more. I would have to.  I would not accept electronic signatures on tax forms.

That last one is obvious.

IRS To Monitor EINs

The IRS this past Wednesday issued proposed regulations requiring taxpayers with employer identification numbers (EINs) to update them periodically with the IRS.

EINs are issued to businesses, trusts and estates.

What the IRS is concerned about is listing nominees on the original EIN application as officers, partners and what not. The nominee’s authority to act and represent thereafter expires, sometimes as soon as the EIN is received, thus obscuring the true ownership of the entity.

The IRS will be revising its application form – the SS-4 – to identify when a nominee or agent is obtaining an EIN for a principal. The IRS will refer to such nominee as a “responsible party.”

The IRS also states that it will provide further rules on updating EINs – such as forms and frequency - in the future.