By Lynda Foertschbeck, Executive Vice President, IRSCompliance, Inc.
The IRS has stepped up its review and audit activity relating to foreign payments. In fact, they have stated that they will review or audit all businesses which make or could issue foreign payments.
Why is the IRS paying so much attention to foreign payments now? The answer to that question involves understanding why the IRS has increased its scrutiny of information reporting in general.
What is the Problem?
Many organizations find information reporting to be tedious or mind-numbing at best. It amounts to added work and a cost of doing business. For example, if you hire a cleaning company to clean your office space, you not only have to select the best vendor for the job, but are also responsible for protecting the government’s interest by obtaining the required information to ensure proper tax reporting. If by chance you fail to do this, or you obtain incorrect information, you can be forced to pay penalties, interest and, more importantly, the dollars that should have been withheld.
For many businesses, collecting payee and payment information and reporting to the IRS is a routine process. The payer collects the information, reports the payments at year’s end, and asks for penalty waivers if necessary.
When information is reported incorrectly, organizations can, in some cases, have their penalties abated. However, the IRS is becoming increasingly selective when granting abatements and is more often requiring documented proof of claims. The result is that more abatement requests are being denied (partially or in full), which adds risk and costs to information returns.
Why is the IRS being more selective?
The short answer is money. But it’s not their desire to get more of your money. It’s their desire to get all payers to comply with reporting and withholding regulations, allowing the IRS to collect the correct amount of money from your payees.
How much money can we be talking about? For that we have to look at IRS data. The following comes from the IRS’ Statistics of Income (SOI) Division.
For calendar year 2008 there were nearly 1.9 million information returns filed by businesses large and small. The majority of these had the correct information reported. Also, a large volume of these documents were for transactions where back-up withholding does not apply. But there were 4.83 million notices mailed to individual taxpayers, notifying them that they had either underreported their income or failed to file a tax return.
Of the 4.83 million notices mailed, 3.53 million taxpayers underreported their income, with the amount of tax owed totaling $6.396 billion. The remaining 1.3 million taxpayers who failed to file a proper tax return owed $10.1 billion in tax, interest and penalties.
What does this have to do with foreign payments?
Simple - enforcement. Enforcing that payers comply with regulations concerning payments issued to U.S. and Foreign Payees (along with new IRS regulations) will result in billions of tax dollars being recovered.
The U.S. Treasury and the IRS have invested time, money and resources into determining where there are gaps in tax withholding and deposits. They have also focused on how to verify that payers have required payee documentation before issuing payments.
Based on the results of these studies, they have determined that the majority of companies do not have proper or adequate procedures and processes in place to identify foreign payees, do not collect and maintain the correct payee documentation, do not apply the correct withholding, and do not report information returns as required.
The IRS estimates that the amount of underreported federal withholding tax for cross border (i.e. NRA withholding) payments exceeds hundreds of millions of dollars annually.
What’s my exposure?
It’s impossible to say whether your company will be audited, but if you are, it’s best to go ahead and plan for the worst. Many companies that have been hit the hardest by the audits were:
- Unaware that they were not properly identifying and processing foreign payees properly and/or
- Believed that their company did not issue payments to foreign payees and/or
- Did not understand the regulations for Form W-8 certification and the application of tax treaties and/or
- Had expired payee documentation and/or
- Did not properly track and re-document any U.S. (both citizens and resident aliens) payees who move out of the U.S. and now may be a foreign payee and/or
- Did not know when a U.S. TIN is required on Form W-8 to allow treaty benefits or exempt status
The increased audit activity has already begun, with many companies being contacted either through an IDR Letter (Information Data Request) or an audit notice from the IRS. Once this process begins, it is difficult to cure your internal procedures or to correct past failures. Any withholding liability, penalties and interest will then apply.
Are more changes coming?
Additionally both the House and Senate versions of a health bill contain clauses that require Form 1099 filing on payments for goods and services made to U.S. corporations. The requirement to document, withhold and report the purchase of goods from a foreign payee could also be required in the future. Whether the two legislative bodies coordinate these two pieces of legislation or insert the 1099 clause in other legislation, we can expect that they will look at foreign payees as well to generate tax revenue. This could easily lead to changes for foreign payment reporting regulations.
So it is time to ensure that your house is in order and that you are able to withstand a review by IRS.
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