At the beginning of every calendar year, organizations are tasked with properly reporting payments to many of their vendors using IRS Forms 1099-NEC for nonemployee compensation and 1099-MISC for a range of other payments. On the surface, these are short forms that don’t appear too complicated. However, don’t be fooled: The rules regarding when to issue a Form 1099 can be confusing. Organizations preparing the forms need to consider a host of details to avoid penalties related to improper reporting. Fortunately, there are several best practices your organization can follow that will help you achieve annual compliance.
The key is to review these recommendations and start preparing before your organization enters the brief (and hectic) compliance season in the first part of the calendar year. Note that 1099s may be due as early as January 31 following calendar year end; this scenario leaves very little time to gather relevant information and update records, while simultaneously compiling the payment data that must be included in the reports. The last quarter of the calendar year is an excellent time to review internal processes and reach out to vendors for any updates to their key information. This preemptive action can help prevent the kind of surprises that domino into other issues, which could result in missed deadlines.
Review your process for obtaining Form W-9
A great place to start is to confirm you’re properly gathering Form W-9, Request for Taxpayer Identification Number and Certification, from each vendor or independent contractor you do business with. The best way to safeguard your organization is to require every new vendor or contractor to complete a W-9 before you approve payment for services. The IRS also requires updated W-9s when your existing vendors change name, address, billing entity, etc. An annual review of the W-9s your organization has on file for all vendors and contractors is a best practice for ensuring you have the most accurate up-to-date contact information available before 1099s are generated. The form will include their business entity type and the Social Security number or employer identification number associated with the individual or business — information you will need for completing a Form 1099, if required.
File Form 1099 electronically
IRS rules require electronic filing of Form 1099 for organizations that meet the relatively low threshold of 10 returns per year. This counts an organization’s returns in aggregate, including the federal income tax return, federal information returns, all 1099s, all W-2s, etc. In other words, most organizations must file the majority of their returns through an electronic process.
This can be completed free of cost using the IRS’ Filing Information Returns Electronically (FIRE) system. But first, organizations must file with the IRS to get a Transmitter Control Code (TCC). This code allows the IRS to prevent bad actors from accessing the system and filing false returns. It could take a couple of months to obtain a TCC, so organizations that expect to meet the 10-return threshold and want to take advantage of this free filing system need to apply for a TCC in the third quarter of the year, in advance of their filing period.
It’s important to note the IRS filing system doesn’t satisfy state or local filing requirements, so organizations should consult with their tax advisors to find out if any additional filings are needed for those jurisdictions.
Know when a Form 1099 is required
In general, IRS rules allow for an exemption from issuing Forms 1099 to corporations, including limited liability companies (LLCs) that are treated as C or S corporations for tax purposes. However, certain types of payments don’t qualify for this exemption from filing 1099s, including:
- Medical and healthcare services payments.
- Gross proceeds paid to an attorney.
- Cash payments for the purchase of fish for resale.
- Substitute payments in lieu of dividends or tax-exempt interest.
- Pay special attention to medical and healthcare services.
Organizations should file a Form 1099 to report payments made in the course of their trade or business to each physician or provider of medical or healthcare services that received $600 or more during the year, regardless of the vendor’s choice of business entity. Regarding direct patient care, if a provider is employed by a third-party corporation, list the corporation as the recipient rather than the individual providing the services. Include payments made by medical and healthcare insurers under health, accident, and sickness insurance programs. Don’t issue payments to healthcare insurers, as the exemption from reporting insurance payments still applies.
Some payments to persons providing healthcare services often include a mixture of both healthcare services and goods. When the supplies aren’t the main reason for the purchase, the entire payment is subject to information reporting and should be reported on Form 1099. For instance, payments for lab or phlebotomy services where supplies for drawing blood are included on the invoice would still be subject to information reporting requirements. On the other hand, an organization isn’t required to report payments to pharmacies for prescription drugs or other payments that are predominantly for goods, inventory, or supplies.
Payments made to tax-exempt hospitals or extended care facilities — or to a hospital or extended care facility owned and operated by the United States (or its territories), a U.S. state, the District of Columbia, or any of their political subdivisions, agencies, or instrumentalities — are not required to be reported on Form 1099. (As tax-exempt or government entities, they are exempt from reporting this income.)
Examples of proper information reporting of medical or healthcare services include the following:
- Patient laboratory testing performed by a third party is likely to be considered a reportable payment that should be reported in Box 6 of the 1099-MISC.
- Payments to a durable medical equipment (DME ) supplier for the purchase of insulin needles would not be reportable, as the purchase is for medical supplies.
- Contracted medical services for an organization’s patients or residents would be reported on a Form 1099, even if the vendor is a corporation.
Beware the 24% backup withholding
The government can require payers to withhold payments reported on Form 1099 — at the rate of 24% — to a vendor or contractor with an incorrect taxpayer identification number on their W-9, or who fails to report (or underreports) income on its federal income tax return. The 24% backup withholding must begin immediately and be remitted through the EFTPS. This measure allows the IRS to ensure tax is paid on amounts that the vendor should have reported as revenue.
If an organization suspects necessary taxes haven’t been withheld properly for these payments (for example, if it discovers it failed to properly issue an accurate 1099 to a vendor), the organization may issue Form 4669, Statement of Payments Received, to request confirmation from a vendor that the vendor reported the amounts properly for the vendor’s own income tax purposes. If the organization cannot obtain an accurate Form 4669 from the vendor, withholding of 24% may be required for all payments to that vendor.
Prepare for information reporting season
The last few months of the year are a critical time for organizations that want to improve the quality of the information reports that they supply to their vendors and the IRS. Consider these key steps for improving the process:
- Review the W-9 forms on file for all vendors.
- Reach out to vendors to confirm any updates for older W-9s.
- Match the information on the reviewed W-9s to the vendor information in the accounts payable system. Taxpayer identification numbers and the type of business entity are key fields to review for accuracy.
- Review a sample of payments made and information reports issued to confirm that your system is working properly. Identify potential areas of concern.
- Train those who manage the payments process to understand what types of payments may be exempt from information reporting (like payments to corporations), and what types of payments may not qualify for those exemptions (like medical and healthcare payments).
- As needed, review and respond to any correspondence from the IRS regarding inaccuracies in information reports that your organization has provided in the past.
Respond to notices
Organizations that issue 1099s might receive initial notices from the IRS under Form CP2100, Form CP2100A, and/or IRS Letter 1865C. This type of communication is sent when required information about the vendor or contractor (such as their taxpayer identification number) is missing or doesn’t match IRS records. By issuing these letters and notices, the IRS is requesting that the organization make corrections to the information returns filed. Organizations that receive these notices aren’t considered under exam. However, if the notices go unanswered, the organization’s risk of being picked for examination increases significantly.
Final thoughts: Plan ahead for a smooth information return process
It’s best to review your compliance process for issuing 1099s in the third and fourth quarter of the calendar year, before the limited start-of-the-year window before tax season. Always consult your tax advisor or the Form 1099 instructions and IRS website for updates and changes to filing requirements.
