The best way that I have found to convince a client to comply with IRS rules regarding collecting W9s and issuing 1099s, is by threatening their checkbook. For some, the threat of $260 per incorrect Form 1099 is not enough. For some, the risk of losing a tax deduction isn’t enough. But would the knowledge of a potentialtax liability of 24% of unreported vendor payments make them take notice? It should. And it is true.

What are the IRS rules for W9 and 1099s? A W9 form informs the payor (employer) of the payee’s EIN or SSN#, and the tax status and name associated with that ID #. Payors are required to collect Form W9s from service vendors in order to determine if the payee is eligible to receive a Form 1099 Information Return at year end. Absent a valid W9, or proof that the vendor is exempt, the payor is required to withhold 24% backup withholding, make Form 945 tax deposits and file Form 945.

Businesses (and nonprofit officers) can be held liable for this 24% (28% pre ’18) tax on PAYMENTS MADE at the point of the first payment if proper W9s are not collected resulting in improper or missing 1099s. There is no comfort in waiting for the IRS to send a CP2000 letter requesting backup withholding moving forward.

1099s filed with no EIN are guaranteed a CP2000 letter.

Employer noncompliance has also been discovered when contractors are under audit for nonpayment of taxes. The IRS will follow the contractor’s income back to the employer and attempt to assess 24% in taxes.

An IRS Tax Case

The following is a snippet from one of many IRS tax cases involving improperly prepared or missing 1099s. (Note that payments made pre ’18 are taxed at 28%)

[.. an employer is not generally required to withhold federal taxes on payments to independent contractors.

20 But if an independent contractor fails to provide a taxpayer identification number (“TIN”) to the IRS, the employer is required to withhold 28% of certain taxable payments.

21 Employers are required to report this “backup withholding” on Form 945.

22 However, even if an employer fails to withhold the taxes, and does not file Form 945, the employer can still avoid liability as long as it can be shown that the independent contractor reported and paid taxes on the payments.

23 The employer complies with this requirement by obtaining a Form 4669 “Statement of Payments Received” from each independent contractor.

24 By filing Form 4669, the contractor declares under penalty of perjury that he or she filed a tax return reporting the payments received from the employer.

25 In simpler terms, the IRS needs proof that somebody paid income taxes on the money that changed hands.

So, if a taxpayer employs independent contractors, he or she has to either:
(1) Provide the contractor’s TIN,
(2) File Form 945 to report the backup withholding on these payments, and pay the backup withholding, or
(3) Obtain a complete Form 4669 from each independent contractor.

26 In this case, according to the IRS, Quezada did none of these three.]

Reference http://bit.ly/QuezadaTaxCase