Accounts Payable Best Practices and Advanced Tax Planning for Year-end
August 10, 2021 - Editors Note: This blog was originally published in September 2019 and has been updated for accuracy.
In today’s evolving business environment, businesses rely on accounts payable for the important task of paying vendors for goods and services. For some companies, this involves numerous transactions and maintaining vendor relationships that help companies grow. While generating revenue from customers is a major goal of any business, accounts payable is equally important on the expense side of the business.
Managing accounts payable has a two-fold effect for the business; expenses paid are accounted for in the financials, and the income paid to other individuals and businesses is accounted for for tax reporting purposes. This post will focus on the latter—on maintaining vendor records for tax reporting.
Most businesses utilize vendors to perform services to fulfill a business need. Some examples of services include but are not limited to:
- An office remodel project performed by a construction contractor
- Advertising services for design work done for the business
- Accounting and tax work
- Legal services for ordinary business compliance or disputes
- Tech support for IT services
- Office cleaning services
Services performed by non-employees, or vendors, will fall under the independent contractor worker classification. This income is reportable by the paying entity (active in a trade or business) and will trigger form-filing requirements to report the income paid, in most cases on form 1099-MISC. Employees, on the other hand, have their income paid reported on Form W-2. The chart below provides an example of the form reporting based on worker classification. It is important to keep in mind that this extends to global relationships companies have as well. Businesses may also incorporate utilizing a foreign vendor—a vendor outside of the United States—to provide services to them. For more information on foreign vendor reporting, see our blog post Requirements for Withholding on Payments to Foreign Vendors.
Worker Classification Type
Year-end Tax Reporting Form
Foreign Independent Contractor
Worker Classification Type
Taxpayer Identification Form
Foreign Independent Contractor
W-8 (BEN, BEN-E, EXP, IMY, ECI)
While this post focuses on the form requirements and accounts payable processes for classified independent contractors, every business is responsible for choosing the proper worker classification when hiring a worker to perform services for their company. If you have specific questions regarding worker classification for your company, please contact your client manager.
Some common questions that clients ask:
- Is this worker an employee or independent contractor?
- Do we need Form W-9, W-4, or W-8 from them?
- Which vendors require Form 1099-MISC?
- We paid the vendor by credit card—do we still need to issue a 1099?
- We never got a W-9 from the vendor, but the 1099 forms are due January 31st; Now what?
- How do we compile the list of vendors to report for year-end reporting?
Proper documentation on the front end of any new vendor relationship through accounts payable is the most pivotal part of maintaining records and reporting for year-end.
Business owners are busy trying to run the business, keep cash flow moving, and focus on their customers. However, often due to all the flurry of activity, bills due through accounts payable may not receive the highest attention to ease into year-end reporting. Without a dedicated accounts payable person, vendors are generally set up in accounting software without a complete profile established with address, tax ID, legal business name, and tax entity type.
The following outlines some accounts payable best practices that businesses can adopt to ease the tension of year-end close.
Collect W-9s or W-8's from all vendorsRequire that all new vendors you establish a paying relationship with provide a complete W-8 or W-9 to you prior to issuing any payments to them. The emphasis on all includes every vendor a business pays regardless of if they will provide a service, or goods only. This also extends to those vendors that you are able to assume are a nonprofit or corporation—it is a best practice to request a W-9 regardless. This record-keeping practice safeguards your business records as the withholding agent in these types of transactions. Take the extra time to review the completed W-9 provided from your vendor to ensure all fields are complete and the date and signature line are completed.
Example: A business hires a lawn service company to provide lawn care during the summer months at their office location. Upon signing the contract for the lawn care, the business owner requests a W-9 from the vendor prior to services being performed. Generally, the salesperson who you signed the contract with will not have this readily available. The work starts regardless, the first month of lawn care is complete, and you received the first bill for services provided without the W-9 for your records. Prior to issuing the bill payment, re-request directly at their billing office a copy of their W-9. This will encourage the vendor to follow through knowing it will delay payment to them.
The blank W-9 below shows the highlighted fields that are most commonly completed and needed for tax reporting purposes.
Fill in Vendor ProfilesUtilize your accounting software to do the work for you at year-end. This practice means taking the time during new vendor set-up throughout the year to completely fill in the vendor information and check the boxes that allow you to mark the vendor as 1099 reportable. While not all accounting software allows you to do this, having complete vendor profiles will make running a vendor report with names, addresses, and tax IDs easier and more complete at year-end.
Example: You received the lawn care service company’s Form W-9. Most accounting systems allow you to quickly enter the vendor by inputting the business name only, and to then immediately move forward to issuing payment. Because you already have all the taxpayer’s information from the W-9, edit the vendor profile to completely fill in the legal business name, address, taxpayer ID number and entity type.
The entity type matters at year-end, as most corporations are exempt from 1099 reporting. There are exceptions to this rule! By taking the time on each vendor individually at the event of first-time payment, you will find year-end reports complete and ready for review and reporting. Keep in mind that every accounting software is different when it pulls in the vendor information for 1099 reporting. Always double check all applicable 1099 vendors make the list.
Record Keeping for W-9 and W-8 forms and vendor invoicesIf your accounting software allows attachments to vendor profiles and bills, utilize this part of the software. Some programs also allow you to attach the W-8 or W-9 in the vendor profile and attach invoices to individual bills. You should also keep an additional paper or electronic copy outside the accounting software as backup.
Example: The same lawn care service provider charged you for mulch, which would be goods, not services. In general, goods are not 1099 reportable. However, when they are listed together on the same invoice with services, the entire amount paid for both goods and services would be reportable on the 1099. If however, the lawn care provider invoices separately for the mulch, only the service invoices would be reportable. Having the support linked in your accounting software can help you easily determine year-end amounts to be used on the 1099 reporting.
Perform vendor housekeeping annuallyIf your company has received the IRS B-Notice letter (a notice the IRS sends when there are name and/or TIN matching errors on the 1099’s filed) then it’s a good idea to perform a full housekeeping of your vendor lists. And regardless of whether or not you have received a B-notice, it is recommended that every business reviews their vendor lists for complete and updated vendor information, annually.
It is especially important to re-request an updated W-9 from a vendor you receive a B-Notice—this notice usually means something with the EIN/SSN provided does not match the tax entity name associated to it. Some issues could include that a business changed their name, provided a DBA (doing business as) name instead of the legal name, or the vendor may have simply filled out the W-9 in error.
This is especially common with sole proprietorships. Sole proprietorships, while they may have an EIN, will be recognized by the individuals SSN and name along with the doing business as name. Combing through your vendor list is a good way to designate old vendors as inactive in order to clear out excess names and allow you to focus on maintaining complete profiles on the vendors you regularly use.
Example: You receive a W-9 from John Doe, doing business as John’s Lawn Care. On the W-9, John checks the Individual/Sole proprietor or single-member LLC box but only lists John’s Lawn Care and EIN. For 1099 reporting, the 1099 will need to list John’s individual name associated with the business and not the DBA name alone—the IRS will then have an easier time matching it to John’s individual name and SSN than if the DBA name and EIN had been used instead in these sole proprietor instances.
Monitor vendors that are paid by credit cardFor 1099 reporting, those payments made by credit card or PayPal are reported on 1099-K by the third party processor. If the business also reports these payments on 1099-MISC, the potential exists for income to be double-reported. Therefore, at year-end a business owner should review the general ledger detail to determine where the source of the payment originated from (for example, check, credit card, PayPal, bank EFT). If a vendor is paid by both credit card payments and checks, the business is responsible for the check portion of payments being reported on the 1099.
Example: John’s Lawn Care accepts either credit card or check for remittance on their invoices to you. Based on the year-end vendor report, you are able to break out the detail by transaction and determine that in total you paid John’s Lawn Care $1,500.00 for the year. If $500 of that total was paid by credit card transactions, only $1,000 would be reportable on the 1099-MISC for services provided. In the accounting software, it is important to pay the bill or record the expense using the correct payment type coding.
It is important and encouraged to maintain clean vendor records to be ready for an audit and also for tax reporting purposes. Most of the items in this blog come from experience working with clients as they navigate one of the busiest times of the year for their companies. That month is January! During that month, or shortly before or after it, many businesses perform year-end closes, issue W-2’s to their employees, and compile lists for 1099 reporting. From experience, it can be a stressful time for businesses to fit in so many important tasks into a short 31-day window. This time of year is very important as the taxing agencies rely on businesses to correctly report payments made to other individuals and businesses.
While it can pose a challenge to focus on the big picture of your business and growth, it is always a good idea to allocate time or resources to the finer details of your company to strive for compliance and record keeping excellence in your accounts payable.
Redpath and Company
Redpath and Company help clients make more informed decisions that contribute to their financial well-being by providing proactive, innovative, and value-driven CPA and advisory services for closely-held businesses, private equity, government entities, and nonprofit organizations. Core commercial industries served include retail, manufacturing, distribution, construction, real estate, engineering, and technology. Areas of service expertise include audit and assurance; personal, business, and international tax; state and local tax; sales and use tax; and succession and estate planning. Redpath also guides clients throughout the entire business life cycle with M&A advisory services (corporate and deal strategy, transaction support, and integration); accounting and financial management outsourcing; and valuation services. The firm was founded in 1971 and is employee owned (ESOP). With offices located in St. Paul and White Bear Lake, Minnesota, the firm ranks as one of the top CPA and advisory firms in Minnesota and is a top 120 firm nationally. Redpath is a member of HLB International, a global network of independent advisory and accounting firms. For more information, visit www.redpathcpas.com.
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