Is Your Organization Prepared for the IRS?
By: Jill Dymtrow and Kelli Wooten, Directors, CTI Tax Solutions, a division of IHS Markit
It is no longer a question of if your organization will be audited on information reporting and withholding, it is only a question of when. Compliance with these rules has grown more complex than ever in recent years, and these changes are presenting new difficulties for even the most responsive organizations.
The concept seems straight-forward. Prior to making payments, an organization must document vendors to determine their tax classification, review the payment type to determine withholding and reporting obligations, deposit any required withholding with the IRS, and after year-end report the payments made to vendors on Forms 1099 and 1042-S. However, both documentation and reporting have recently undergone significant changes. Keeping up with these changes can be a major challenge in the accounts payable environment where time is money, and the pressure to pay vendors is on.
The cornerstone of a healthy compliance process is documentation for both U.S. and foreign vendors. This is no easy task, as two revisions to the Form W-9 have been issued since August 2013. Forms W-8 underwent a major transformation in 2014 as well, bringing what were traditionally one and two page forms to lengths of up to eight pages.
As for reporting, Forms 945 and 1099-MISC did not see any major changes in format, but the Forms 1042-S and 1042 were completely redesigned. One 1099 item to note: the new early deadline for reporting nonemployee compensation to the IRS (January 31)- what generally makes up the largest portion of 1099 reporting for vendor payments organizations.
Unfortunately, penalties for noncompliance are only set to climb higher. Effective January 1, 2016, penalties more than doubled for 2015 and forward filings and were adjusted upwards for inflation. It is also important to remember that Forms 1099 and 1042-S require filing of both the information return report which is provided to the IRS as well as the payee statement. Generally, this means your organization can plan on most penalties being doubled, such that a mistake on a particular payee's Form 1099 or 1042-S which is duplicated on the IRS filing can now cost $520 versus the previous $200. The annual cap per legal entity has also increased from $1.5 million to just over $3.0 million. The penalties for intentional disregard, the "you should have known better" penalty will increase from $250 per occurrence to $520 per occurrence, meaning $1,040 in total, (or 10% of the payment amount, whichever is greater) with no annual cap. Couple this with an IRS that is increasingly willing to assess intentional disregard and the numbers quickly add up to uncomfortable discussions with senior leadership, disclosures to audit committees, and a significant check being cut in favour of the IRS.
Correction filed within 30 days
$50 per occurrence
Correction filed by August 1
$100 per occurrence
$260 per occurrence
Intentional Disregard (maximum penalty of 5 or 10 percent of the amount that should have been reported remains unchanged)
$520 per occurrence
Given these external pressures, it is critical to review organizational processes to make sure you are prepared for an IRS audit. An audit can, and must, be managed from the time the IRS delivers the first information request. However, paving the path to audit success must begin much earlier.
Has your organization developed an end to end roadmap for compliance? If not, the time to do so is now. Information reporting is often a forgotten process in many organizations without a clear home or technical support. Tax organizations frequently insist it is an accounts payable responsibility without providing any tax technical guidance. Accounts payable organizations often see information reporting as a distraction from the overwhelming requirements of day to day business. As a result, there is a lack of end to end governance which creates issues that can slip through the cracks year after year.
While defining an end to end roadmap will take time, it is a critical component for success. Invite the various stakeholders to the table – this generally will include accounts payable, tax, human resources (for payments related to death benefits, etc.), legal (litigation settlements, gross proceeds paid to attorneys, etc.), the corporate secretary's office (payments to board members), treasury (payments to the IRS), information technology (generating reports systemically). Scheduling an intensive two to four hour session early in the project for everyone to meet in person and map out the process is extremely useful. Try covering a conference room wall with paper to map out every input, task, and output with a critical focus on the hand-offs between organizations. This systemic exercise helps make sure every organization knows what is required and understands the various inter-dependencies. From experience, it is critical to have selected the end to end process owner prior to this activity. This process champion will be key as he or she will need to understand each piece of the process, the role each party plays, as well as the applicable requirements. This individual will also be responsible for communicating any changes in regulatory requirements. Some organizations even make this a joint role between accounts payable and tax, given its importance to the process.
Once you have designed the end to end process, you need to develop a policy and procedure manual. This manual will be the first item requested by the IRS as part of an audit. Importantly, this is not a once and done exercise – the manual should be updated at least once a year, and more often if required. Producing a tattered manual which was last updated in the 90's, or worse yet, providing a rambling explanation of why your organization does not have a manual is not the first impression you want to leave with the IRS.
Once you have drafted the manual, follow it for several weeks to eliminate any holes in processes. The goal is to make sure each step of compliance is seamless. If the policy indicates requirements spanning more than one organization, make sure each team impacted has had an opportunity to review and sign off on the procedure. It is critical to include all necessary templates, examples, passwords, websites, etc. that are needed and often helpful to include screen prints to detail specific steps in a process.
Importantly, you want to make sure the document refers to roles, not people – e.g., "Accounts Payable Supervisor" as opposed to "Susan." Individuals may change roles, retire, or otherwise leave the company, and it is critical that the successor understands what the policies and procedures require of him or her. For example, the IRS has little tolerance for being told backup withholding payments were not made because John was listed as being responsible for them and Rebecca now held that position. Clearly stating that the Treasury Analyst was responsible for making payments would have eliminated this issue.
As a next step, make friends with your organization's internal audit or controls function. These organizations are focused on minimizing risk to your company and will often times have excellent suggestions for how to "test" compliance that will enable you to quickly spot areas where simple process changes now can prevent costly remediation efforts later. These teams may lack subject matter expertise; however, consider either having your process champion conduct the training, send team members to a conference, or bring a subject matter expert in for an organization wide training.
The IRS is also increasingly focusing on penalty notices as a tool for collecting revenue. Over the past several years, the IRS has significantly updated its technology capabilities to focus on automatic penalty (or notice) generation for B Notices and other issues which may have escaped unnoticed in prior years such as late-filed forms or forms corrected after the filing deadline. IRS notices generally include a date, a tax year, a tax form, and some type of notification of the action the payorshould take.
There are two NEVERs in managing penalty notices – NEVER pay a penalty notice without first considering a request for abatement and NEVER assume the IRS is correct without doing your own research.
The first step is to identify the date by which a response is required. Generally notices must be responded to within thirty days. If the notice has been floating around your organization looking for a home for an extended period or you are otherwise not able to respond within the timeline provided, you need to contact the IRS at the phone number listed on the form and ask for an extension. The agent will provide you with either his or her name and badge number which you should keep in your records. The IRS has traditionally been generous granting these requests, particularly if it is your first request on a 30 day notice.
Next, start researching the issue. For example, if it is a penalty for name / TIN mismatches for which you received B Notices, make sure the details such as the numbers of mismatches are consistent with the actual B Notices. Your objective in responding is to show "reasonable cause." To do this you must demonstrate that your organization acted in a reasonable manner and that there were either significant mitigating factors or other events beyond your control. Just making these claims is no longer enough to receive an abatement, rather you must clearly demonstrate reasonable cause and provide evidence to support your claims. To this end, you want to demonstrate compliance with IRS requirements. For example, with respect to a name / TIN mismatch penalty notice, consider demonstrating that you have a robust vendor onboarding process in which you obtain a Form W-8 or W-9 from each vendor with any U.S. taxpayer identification numbers being validated via the IRS TIN Matching System or for which backup withholding is imposed. Include as support for your position a sample copy of a collected Form W-9, appropriate excerpts from your policy and procedure manual, a sample TIN matching result worksheet, samples of B Notices sent in response to notices, etc. Go overboard in supporting your position – you are effectively writing for dollars at this point.
The next step is to demonstrate either significant mitigating factors or other events beyond your control. For example, a significant mitigating factor would include an established history of compliance. This is where you want to start citing statistics. Make the numbers work for you – e.g., "B Notices represent .02% of Forms 1099 filed," as opposed to "there were 756 B Notices." Another example would be that your organization has never previously been required to pay an information reporting or withholding penalty. This is why it is not recommended to simply write a check in response to a penalty notice. There may be times when paying a penalty is less costly than creating an abatement request, but paying a small penalty today may negate your ability to be granted an abatement for a larger future penalty.
In the alternative you can also demonstrate that there were events beyond your control. For example, here you can mention your robust TIN matching process for newly onboarded vendors that yielded a valid result in September and a B Notice the following October. The vendor had provided a valid Form W-9; however, had failed to update your organization on a change in circumstance.
Once you have finalized and aligned the narrative and supporting materials, arrange to have the abatement request signed by an authorized signatory for the entity. You will want to send the complete response including the narrative, documentation, and notice page with barcode to the IRS office listed and keep a signed copy for your files. You always want to send communications to the IRS via certified mail, return receipt required and keep both the proof of mailing and receipt attached to the copy included in your records. It will cost a few dollars more; however, it is well worth it when the IRS misplaces your response and claims it was never received.
Whether it be a penalty notice or an audit, the information reporting and withholding stakes have never been higher. This makes it the perfect time to step back and review your processes to make sure they are aligned with IRS expectations. Time invested in developing an end to end process, creating a robust policy and procedure manual, and enlisting internal audit or other support for monitoring will save both time and money later.