When the IRS sends small business owners letters, the agency doesn’t always expect a response.

Case in point: A client popped into my office the other day with a piece of correspondence from the IRS about 1099 forms that he issued back in January. He was confused about the reason for the letter and was seeking my input.

The letter was instructing him to begin back up withholding on two of his 1099 vendors because the ID numbers that were used did not match what IRS had on its records. The IRS didn’t expect a response to the letter, it was just an instruction to make sure going forward that the correct ID number was used or to use backup withholding to prepay the person’s income tax and possibly a self-employment tax liability.

A mismatch in ID numbers can occur in a couple of different ways. You could have mistakenly typed in a wrong number for the tax ID number, which is usually a federal ID or the vendor’s Social Security number.

Double check the number the IRS displays in the letter to the Form W9 your vendor completed when he/she began doing business with you. Perhaps you erred when you completed the Form 1099.

The most common error I’ve seen is using a Social Security number when showing the payee’s business name on line one of the Form 1099. This will create a mismatch because Social Security numbers are issued to individuals, not businesses. Simply correct your records to show the name of the business owner first with the company name listed below it. The IRS will match against the first line of the Form 1099 without regard to the business name.

Now is the best time of year to begin the process of reviewing vendor files with an eye to 1099 preparation. Make sure that you have a completed Form W9 on file for each vendor who provides a service in excess of $600.

If you use QuickBooks to track your income and expenses, pull down a 1099 detail report. Go to Reports, Vendors & Payable, 1099 Detail, to generate a report to date to find out if you need to obtain any ID numbers. It’s easy to get busy during the year and neglect to get the information necessary to provide this important document at year end.
 

Make sure you have set up your “Preferences” in QuickBooks to outline the parameters of 1099 payment.

Go to the top ruler bar and select “Edit” and at the bottom of the pull down menu is “Preferences.” Then select Tax: 1099. Under company preferences tab, click yes on the question about whether or not you issue 1099s. Then map your company’s accounts. This basically allows QuickBooks to track amounts under the categories that apply: subcontract labor, hauling, accounting, website development and any other category that represents service work performed for your business. And don’t neglect to include your landlord under box 1: rents paid.

If anyone refuses to provide an ID number, you can bet they are working under the table and not paying taxes on their income. This leaves you in the tenuous position of either picking up their tax tab – after all, in audit the expense you incurred will be disallowed if you did not issue a 1099 – or performing backup withholding, which will likely destroy the relationship. Without the vendor’s ID number backup withholding is the requirement.

Bonnie Lee is an enrolled agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, Calif., and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Her new e-book Taxpertise for the Creative Mind Murder, Mayem, Romance, Comedy and Tax Tips for Artists of all Kinds is available at all major booksellers. Follow Bonnie Lee on Twitter and on Facebook.