New vendor onboarding and vendor record upkeep are insignificant administrative tasks, right?
Tell that to the CPO or department head when you hold up a vendor payment because you don’t have a tax ID. Or to your finance VP or CFO when you just found out you paid money to a phony vendor. Tell it to your CEO when the Treasury Department agents in black suits and no sense of humor show up at the office.
Administrative? Sure. Insignificant? Hardly.
When it comes to vendor onboarding, the devil is in the details. Onboarding is not a “mere” administrative activity. It involves crucial information and critical functions, including vendor validation, payment information capture, sanctions clearance verification and tax classification for reporting and withholding status.
Vendor validation, information capture and verification of sanctions clearance are each vital in the process of onboarding a new vendor. If you are charged with responsibility of the vendor file and don’t know what these mean, you need to find out! But here we are going to focus on tax classification. Why is it important and what does it entail?
Why It Matters
U.S. organizations are required by law to report to federal and state governments certain payments they make. It’s part of the governments’ efforts to close the “tax gap” – that gap between tax owed and tax received. A major cause of the tax gap is taxpayers underreporting income. Companies report payments made to employees on form W-2. But they must also report certain payments made to non-employees on form 1099-MISC.
The consequence of failing to meet your organization’s responsibilities to report, and in some cases withhold a percentage of payments, is that the IRS will fine you. There was a time when the fines were fairly inconsequential. But over the past several years that has changed, as the IRS has significantly increased the fines.
It matters too in addressing the issue up front in a relationship with a vendor, rather than have to spend valuable time later tracking down vendors to correct the record.
How do you know which payments have to be reported, and to which vendors? To answer those questions, you need tax classification information from your U.S. and non-U.S. vendors. And you need this information before it’s time to pay them. Once you’ve paid them, their incentive to provide you the information is considerably reduced.
Without the information, the IRS says you must backup withhold 39.6 percent from the payment to a nonexempt payee that has not furnished a taxpayer identification number. And without the W-9, you might not know whether the vendor could be exempt. If you fail to meet the reporting and backup withholding requirements, it’s going to cost your company.
What It Entails
Backup withholding does not apply to all payments, nor are all payments reportable. Many vendors are exempt from reporting — for example, corporations. Certain payment types are exempt given the right kind of documentation — for example, expense reimbursements made under an accountable plan to a service contractor. AP staffers have to learn the rules and know what to look for. It gets especially complicated with foreign vendors.
You have to know and document in the master file the vendor’s country status and tax classification, which depends on organization type. And the rules are different for non-U.S. vendors.
IRS Forms W-9 and W-8 are designed to provide tax classification information, so the starting point is to obtain the appropriate form or acceptable substitute form from the vendor.
Sometimes the vendor is unclear about which form to provide you (especially foreign vendors). Sometimes they provide incorrect information regarding their tax classification – the little bit of good news there is that if you have the documentation on file, and the IRS determines you have the wrong classification and therefore did not report or withhold correctly, you are not penalized for acting on the documented information the vendor provided. But you are responsible to go back and sort it out with the vendor.
Correct reporting entails knowing which payment types are reportable, and to which types (tax classifications) of vendors. It’s important to understand the rules. There are tools that also can help you and your vendors to determine which form they should use and that make it easy to submit. For example, VendorInfo’s Vendor Compliance module guides your vendors through a series of questions to lead them to the correct form, which they can then complete and submit to you, all online. (The same module then runs a TIN match against the IRS database, and also validates the vendor as well as checks it against the government sanction lists.)
When it comes to payment reporting and backup withholding requirements, get it right, or get B-notices and IRS penalties!
To see how VendorInfo’s onboarding solutions can benefit your operations and your company click here to request more information or call (678) 335-5735.