Understanding Backup Withholding and the Importance of W9 Forms for Contractors

Welcome to the Profitable Painter Podcast. The mission of this podcast is simple: to help you navigate the financial and tax aspects of starting, running, and scaling a professional painting business. From the brushes and ladders to the spreadsheets and balance sheets, we've got you covered. But before we dive in, a quick word of caution: while we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant. We strongly recommend you seeking individualized advice before making any significant financial decision. This is Daniel, the founder of Bookkeeping for Painters.

And this is Richard, tax director for Bookkeeping for Painters.

How's it going?

It's going good, Daniel. I'm getting ready to go on vacation starting tomorrow. So we're going to take the family down to the beach for a little while. This is kind of the slow season for taxes and trying to take advantage.

Yeah, that sounds awesome. You going to do any jet skiing or surfing or anything?

Probably not. We're going to Florida. My son is really into, like, space and astronomy. So I think we're going to try and go to the Kennedy Space Center there. I was there when I was a kid, like a school trip, but he's never seen it and I think he'd really enjoy that.

Oh yeah, that sounds like a lot of fun. That's awesome.

Yeah. Yeah. Cool. So, you know, it's not a lot of fun.

That's a good segue. As what's not a lot of fun? Yeah.

Backup withholding. And I know most people are saying, what is backup withholding? Yeah, it's, it's something that we don't really talk about a whole lot. Tax-wise, but if you do business with contractors, it is definitely something that you need to be aware of.

Yeah, I, you know, a lot of folks think it's optional, you know, when they're hiring their, a new subcontractor. There's sometimes this negotiation that goes on like, hey, I don't want to fill out a W-9, just go ahead and just pay me and I'm not going to fill out W-9 and and I'll work for you. And some folks get caught in this thing where they don't take it, you know, have their new subcontractor fill out a W-9, and they kind of get in some cases some big trouble. So from what we've seen working with other folks, even when they were trying to do the right thing, you know, you can get in some messes with the IRS on this topic.

Yeah, I think what happens is a lot of times if we're a business owner, we assume that because it is our contractor's responsibility to pay his own taxes, that we can write him a check for his services and not have any liability or responsibility to that payment. And if we do things correctly, then yes, that's true. But we do have an obligation as the payer to have certain information about the person we're writing the check to. And that's going to be name, address, and tax identification number or Social Security number. And the IRS does have a form that we can use to collect that information. You mentioned it, Daniel. It's the W-9, although you could get that information from other methods. I do recommend having a signed W-9 just, you know, for good record keeping. Sometimes people struggle with like how to fill one out or when they need to request one. So I thought maybe we could just kind of go over the W-9 real quick and kind of—

yeah, that makes, that makes sense. And, and maybe even go a little bit before that. Some folks don't know how they should be paying a worker, you know, a worker is either classified as a contractor or an employee. If you're not paying them through payroll, you know, formally through payroll, you probably should be paying them as a contractor. We had a whole separate podcast on how to distinguish between a contractor and an employee. So if you are unclear on that, definitely reference that podcast. But once you establish that this is a contractor, you'll need to step number 1, get that W-9 information. Yes.

If you are paying them for services and you are going to be paying them more than $600 for the year. So that's not more than one $600 check, but, you know, cumulative throughout the year. And you're going to be paying them either cash, check, or cash equivalent. then you need to get a W-9 from them. There are a few exceptions to that. If the person you are paying is a corporation or is being taxed as a corporation, then you don't need to worry about getting that W-9. But if they are a sole proprietor or they're an LLC that is disregarded for tax purposes, So an LLC that files their taxes on their 1040 Schedule C, then you need to get that W-9. Yeah.

And I think it's a safe bet just to assume any subcontractor you're working with needs a W-9 filled out and you're, you're going to have to file a 1099 on them. That's always the safest route to go is just assume even if they're an LLC, they're, they're probably an LLC disregarded entity that's going to need a W-9 and a 1099. Filed.

Right. And if, and if for some reason they object and they say, oh no, no, this doesn't apply to me, they can fill out the W-9 and state that, you know, it doesn't. So for example, on the W-9 in box 3, it asks, you know, what kind of federal tax classification are you? And if you are a C corp or an S corp or some other, you know, entity or structure where you don't need to have a 1099 issued, they can mark it there and, you know, sign at the bottom under penalties of perjury that this is all correct and that exempts you of your responsibility. But, but yeah, Daniel, I agree. Like, have them put it in writing. Don't just take their word for it. So that way you're not caught off guard.

Mm-hmm. And a good— and this really needs to be done before they do any kind of work for you. You should incorporate this in your process. So I've worked with a lot of folks on incorporating this into their subcontractor hiring process. And a lot of folks, what they're— what they'll do, they'll source their subcontractors a certain way. Maybe they make a post on Craigslist to kind of announce, like, have a little job ad looking for subcontractors for painting or something somewhat. Maybe it's on Facebook, wherever it is. And you push them to schedule a, maybe an interview with you or a, you know, a phone call with you to do some initial screening. So what you could do is, is have them fill out some initial information before you even talk to them on the phone. And that could be a part of that, could be capturing that, that basic information for their W-9, their W-9, either having them fill out a W-9 or the information for the W-9. Before you even talk to them, just to make sure you get that information up front so you don't have to go waste your time interviewing them and saying, oh, they're a good fit, and then they pull this whole dance of, oh, I don't, I'm not going to fill out a W-9, you know, and you've just wasted a couple hours of your time trying to screen them and everything. Just get that documentation up as early as possible in your subcontractor hiring process so you're not wasting your time with someone who's going to give you a hard time on this topic.

Yeah, I think that that's smart. I mean, personally, if a contractor refuses to do a W-9 for me, I probably don't want to work with that person. It's not worth the headache. That being said, if you do owe a contractor money and they refuse to fill out the W-9, there are provisions to protect yourself, and that's where backup withholding comes in. So to kind of define what that is, backup withholding is essentially when you withhold taxes from a contractor's payment and then you remit those taxes to the IRS on behalf of the contractor. Now, that's only necessary when you can't get that W-9 and that, that taxpayer ID number or Social Security number. It's important that we do that because if we don't withhold, it's 20— it's 24% is what the backup withholding is. If we don't withhold that 24% and they never give us the W-9, we could become liable to paying that backup withholding to the IRS. And we don't, we don't want to have to pay somebody else's taxes for them.

Yes. And ask us how we know. Yeah, we have had in the past, you know, a client where they paid a subcontractor that they did not have a W-9 on, and then the IRS came after them for their subcontractor's taxes. And the, you know, the business, the painting business owner was trying to do the right thing and correct the issue, get the W-9 from the subcontractor, but the subcontractor just ghosted him. And so now he was on the hook for tens of thousands of dollars to the IRS for this guy that did some work for him.

Yeah. Yeah. It's really kind of a sad situation. And one of the reasons we want to kind of bring attention to this, too, is because this doesn't seem to be very well known. I— my personal opinion is I don't think the IRS has done a great job educating business owners of their responsibilities towards backup withholding and W-9s. And so we kind of wanted to help people understand, you know, the importance of it and the dangers of not having the paperwork correct. So if you are doing backup withholding, then there is a form called Form 945. You're going to file that with the IRS, which tells them how much backup withholding you have. It'll probably also ask for some information about the contractor, what information you might have, and then you'll remit that to the IRS. If you're able to do that, then you've kind of— or you have— you've covered your responsibilities towards this. The contractor can file his taxes and get a refund of whatever, you know, extra has been withheld. But this way the IRS gets paid and they're not coming after you as the, as the payer to try and get someone else's taxes. Now, there's some other situations where backup withholding might come into play, too. Let's say you do get a W-9 and it looks reasonable. The Social Security number has 9 digits. They're all numbers. There's no like exclamation points or letters in there. And it seems legit. So you issue the 1099 at the end of the year and the IRS sends you a letter and says, hey, this number does not match this name. We don't know what this is. That happens sometimes. It's a tax identification number or TIN mismatch. And they might send you a letter saying, because we cannot match the number to the employer or the contractor, You are now required to do backup withholding and you have 30 days to start it and you have to continue to do it until we get a valid number. So that could be another situation. If that happens, then you— and you comply, then you will be protected because you are doing the right thing. But if you never get a number from the contractor, then the IRS's view is that you should have done backup withholding from the very beginning because you had no number whatsoever.

I think— so I think we pretty much covered this topic. I mean, I think it comes down to, you know, get that W-9 as soon as you can in that process. If someone's refusing to fill out that information, probably don't want to work with them. Unless you are comfortable paying them, paying their taxes for them. If they're that good, I would, which I, I don't think that would be the case. So I think that's what it really comes down to. And we probably should do an honorable mention to once you get that W-9, make sure you actually file the 1099s in January so that you're, you're not getting hit with those penalties.

Yes, absolutely. File the 1099 in January. It is $50 a month penalty for every month it is late. And I believe that can go up after a certain period of time. So make sure those get filed. Now, just, just real quick, Daniel, I have had a few clients push back on me on this and they have said, well, I've got a really great contractor. He does a really great job, but he doesn't want a 1099. What would your response be to something like that?

He doesn't want a 1099. It's—

he doesn't want a 1099.

Yeah, it's not as— it's not an optional thing. I don't want to pay taxes, but I'm still going to do it. It's just kind of a silly desire. I mean, okay, we're not in grade school anymore. We have to do our— put our adult pants on and do things we don't want to do. I don't know, that's just a weird thing to be like, okay, that's, that's nice, but, uh, I, I have to abide by the law so I'm not, you know, getting in trouble with the IRS.

Right, right. Yeah, no, it's that serious. It really does need to be We're either going to issue the 1099 or we're not going to do business together because like you said, we don't— I can't afford to pay someone else's taxes for them. And that, that is what will happen if we don't have the paperwork in place. We will end up paying their taxes. Another situation I think is a little bit more common is you ask for a W-9 and they say, yeah, yeah, boss, I'll get that to you right away. And then the week goes by and we don't have it. It goes by, we don't have it. At that point, we need to be able to say to our contractor, hey, you either give me the W-9 or I withhold 24% of your paycheck. That's my legal obligation before the IRS. I imagine withholding 24% of their paycheck would be very motivating. I say paycheck, it's not a paycheck because they're not an employee, but 24% of their payment. That could be very motivating. But yeah, it is that serious. And we do need to kind of, you know, like you said, put our big boy pants on or big girl pants on and stick to that boundary. So, you know, hoe that road. That's not the right idiom, but you know what I mean? Like, stick to that, stick to that line. Because it could be a lot of headache for us later on if we don't.

Absolutely. All right. Second attempt to end the podcast. I'm going to say I think we got it now, hopefully. But if you have any thoughts on this topic, any questions, if you're in a situation where you're dealing with a subcontractor that doesn't want a W-9, Phil, fill out a W-9 or doesn't want to get a 1099 or whatever, throw us the situation in the Grow Your Painting Business Facebook group and we'll see if we can give you some general guidance. And if you have any ideas for topics for future episodes, definitely let us know.

Absolutely. We appreciate you listening and we will catch you on the next episode.