Form W-9 Best Practices (#337)
/The Form W-9
The topic of this episode is best practices for the Form W-9. This is a form that the payer of funds is supposed to send to the receiver of funds, or the payee. The reason for the form is to collect the name and taxpayer identification number of the payee, as well as its form of organization, such as a C corporation or a partnership. After the end of the year, the payer then uses this information to compile a Form 1099, which goes to the IRS and the payee, and which states the total amount that the payer paid to the payee.
Another issue arising from the W-9 is that, in some cases, the payer has to withhold a percentage of the amount paid and send it to the IRS instead of the payee. Which is deeply annoying for all parties concerned. Except the IRS.
So, the W-9 can cause a lot of grief for the payer, because if the information on it is wrong, the IRS will eventually send it a notice, saying that the name and taxpayer identification number on its Form 1099 are incorrect. And this means that the payer needs to keep bugging the payee for more accurate information, in the form of what are called “B” notices. And if the payee doesn’t comply, then the payer needs to start withholding funds from any new payments to the payee. This is a lot of administrative grief that wastes the time of the accounting department. So, what are some best practices for keeping this data collection process as streamlined as possible?
Form W-9 Best Practices
The best option is to require a payee to hand over a completed W-9 up front, before the payer sends it any payment at all. This is the only point at which the payer has leverage over the payee, so it almost sounds like a hostage deal. You give me the completed form, and I give you the money. Lots of companies already do this.
But that is not good enough. The trouble is that the information on the form might be incorrect, in which case the payer is still going to be notified by the IRS of an incorrect 1099. The way to resolve this problem is to go to the IRS’ TIN matching program, which it offers free of charge on its website. Basically, you enter the name and taxpayer identification number into the IRS’s website, and it tells you if you’ve entered a valid match.
If it’s not a valid match, then go straight back to the payee and ask for another W-9 that contains the correct information.
These two steps need to be done up-front, before any payments are made. Otherwise, don’t expect a lot of cooperation from the payee.
A decent third option relates to how the information on the W-9 is laid out. Line 1 of the form contains the name shown on the payee’s income tax return. Line 2 contains a business name, or a doing-business-as name. You should always issue check payments to the name provided in Line 1, not the name in Line 2, since Line 1 is associated with the IRS TIN match, and Line 2 is not. So, if you never use the name in Line 2 in your accounting records, there won’t be a risk of issuing a Form 1099 to that name, and then having the IRS bounce it back at you.
Those are the three absolutely must-do best practices for the W-9. But there are other ones to consider. In particular, watch out for payees that are limited liability companies. If an LLC is a single-member LLC, then the IRS ignores it for federal tax purposes, and assumes that the owner is the actual entity being paid. So, when one of these W-9s comes in, be especially sure to do a TIN match.
And the next LLC problem is… LLCs that are treated as corporations. An LLC can indicate on the W-9 that it wants to be treated for tax purposes as a corporation. If so, that makes it exempt from backup withholding. The problem is, you can’t tell if the LLC has actually filed with the IRS for tax treatment as a corporation. And the only way to find out is to ask for a copy of their Form 8832, which is the Entity Classification Election. Only by getting a copy of that does the payer have proof that no backup withholding is actually required.
Next up is the individual taxpayer identification number, or ITIN. This number is issued to individuals who are required to have a U.S. taxpayer identification number but don’t have a social security number. Historically, there’s been a much higher probability that these numbers will not pass a TIN match, so always do the TIN match when you run across one. And in case you’re wondering how to spot one, an ITIN has nine numbers in the same format as a social security number, but it always begins with the number 9. Also, the fourth and fifth digits are always within the range of 70 through 88.
On top of that, issue a notice to all payees once a year, just to remind them to provide a replacement W-9 whenever their ownership or legal structure has changed. So for example, if a sole proprietorship has converted into a C corporation, this would be grounds for a new W-9.
There’s also a best practice that applies to the payee. If the information stated on a newly-revised W-9 differs from the one the payer already has on file, the payee should write the word NEW at the top of the replacement form. In caps, and maybe in red ink. Doing so increases the odds that the payer will review the form in detail for changes.