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Emerging Compliance Issues Subgroup Report (2008 IRPAC Report)

Issues Covered in this Section:

A. Guidance for Taxpayers Regarding Receipt of Schedules K-1 and Forms 1099 or 1042-S For Income From Interest in a Foreign Partnership

B. To obtain written guidance on whether Treasury Regulation § 31.3406(d)-1(b)(2)(iv)(A) requires an acquiring payor to resolicit taxpayer identification numbers ("TIN") from each affected account holder when it acquires accounts from a third-party payor who has been making reportable payments subject to the Form W-9 certification requirements. 

C. Procedures for complying with Second B Notices appear outdated and should be coordinated with the Social Security Administration’s current policies.

D. Reporting Nonqualified Deferred Compensation Benefits Following Employee’s Death

E. Clarification of Form W-9 and the Corresponding Instructions Regarding the Entity Classification Box for Limited Liability Companies

ISSUES

A. Guidance for Taxpayers Regarding Receipt of Schedules K-1 and Forms 1099 or 1042-S For Income From Interest in a Foreign Partnership

Discussion

Certain income paid to foreign partnerships is reported twice under current information reporting rules.  Since taxpayers generally expect their income to be reported only once on an information return, the duplicate reporting is causing confusion.

Under the Section 1441 regulations, payors are not permitted to treat foreign flow-through entities (nonwithholding foreign partnerships, nonwithholding foreign grantor trusts, and nonwithholding foreign simple trusts) as payees.  As a result, payments to a foreign flow-through entity are deemed to be payments to the entity’s partners, grantors or beneficiaries; and such payments are required to be allocated and reported at that level. 

If the partner, grantor or beneficiary is a

U.S. person, the regulations under Chapter 61 of the Code apply; and all payments of interest, dividends, or broker proceeds are required to be reported on Forms 1099-INT, 1099-DIV and 1099-B.  If the partner, grantor or beneficiary is a nonresident alien, all “amounts subject to reporting” under Treasury Regulation Section 1.1461-1(c)(2) are required to be reported on Forms 1042-S.

Under Treasury Regulation Section 1.6031(a)-1(b), an entity classified for U.S. tax purposes as a foreign partnership is required to file a U.S. partnership return for any taxable year in which it has either (1) gross income which is effectively connected with the conduct of a U.S. trade or business (effectively connected income or “ECI”) or (2) gross income derived from sources within the U.S. (U.S.-source income).  While there are certain exceptions to this filing requirement, no exceptions are available if the foreign partnership has

U.S. partners.  Further, under Treasury Regulation Section 1.6031(b)-1T a partnership that is required to file a U.S. partnership return must also provide Schedules K-1 to its partners. 

As a result, where a

U.S. payor is acting as custodian, and makes (or collects) a payment to a foreign partnership, the partners may receive Forms 1099 (or 1042-S) and Schedules K-1 for the same income.  Further, the tax information as provided by the partnership may not match the Form 1099 (or 1042-S) tax information furnished by the U.S. payor that made payments to the partnership.  For example, a partner of a nonwithholding foreign partnership could receive tax information from the U.S. payor showing their allocable share of gross amounts paid to the partnership on a cash basis, and tax information from the partnership showing their share of income required to be recognized by the partner on an accrual basis.

The dual reporting described above often causes confusion for the taxpayers that receive it.  Such taxpayers often believe that the Forms 1099 (or 1042-S) received from the U.S. payor is incorrect and will cause them to be subject to tax twice on the same income.  They are concerned that the IRS may reject their return if they fail to include all items reported on Forms 1099 (or 1042-S) and Schedules K-1, but don’t know how to treat the dual reporting on their returns.

Recommendation

The Instructions to Schedule E of Form 1040 should be amended to make it clear that Taxpayers may receive Forms 1099 (or 1042-S) in addition to Schedules K-1 for the same partnership income; and to provide guidance regarding the reporting of such income.

IRS Response / Action

The IRS has agreed that Schedule E of Form 1040 will be amended as follows:

1.  On page E-5, change title of “Partnerships” to “Domestic Partnerships”

2.  On page E-6, make "Foreign Partnerships" a freestanding heading and add the following text at the beginning:

Follow the instructions below in addition to the instructions for Domestic Partnerships beginning on page E-5.

If you are a U.S. person, you may have received Forms 1099-B, 1099-DIV, and 1099-INT reporting your share of certain partnership income because payors of income to the foreign partnership generally are required to allocate and report payments of that income directly to each of the partners of the foreign partnership.  If you received both Schedule K-1 and Form 1099 for the same type and source of partnership income, report only the income shown on Schedule K-1 in accordance with its instructions.

If you are not a

U.S. person, you may have received Forms 1042-S reporting your share of certain partnership income, because payors of income to the foreign partnership generally are required to allocate and report payments of that income directly to each of the partners of the foreign partnership.  If you received both Schedule K-1 and Form 1042-S for the same type and source of partnership income, report the income on your return as follows:
  • For all income effectively connected with the conduct of a trade or business in the United States, report only the income shown on Schedule K-1 in accordance with its instructions. 
  • For all income not effectively connected with the conduct of a trade or business in the United States, report on page 4 of Form 1040NR only the income shown on Form 1042-S (if you are required to file Form 1040NR).

3.  Delete the existing first paragraph under "Foreign partnerships" and
replace it with:

Requirement to file Form 8865:  If you are a

U.S. person, you may have to file Form 8865 if any of the following applies.
[Resume existing instructions text]

B. To obtain written guidance on whether Treasury Regulation § 31.3406(d)-1(b)(2)(iv)(A) requires an acquiring payor to resolicit taxpayer identification numbers ("TIN") from each affected account holder when it acquires accounts from a third-party payor who has been making reportable payments subject to the Form W-9 certification requirements.  For purposes of this issue "acquires accounts" means accounts acquired by voluntary and involuntary means (e.g., merger and acquisitions, change of transfer agents, change of plan administrators for employee plans, etc.).

Discussion

Generally, Treasury Regulation §31.3406(d)-1(b)(2)(iv)(A) provides that if a payor acquires accounts of another payor, the acquiring payor must treat the affected account holders as being required to furnish a TIN.

In past years, and today, it appears that the industry practice in the financial services sector is not to resolicit TINs from the holders of the accounts that have been either purchased or transferred from another payor.  This practice is not based on published IRS guidance, although Treasury Regulation § 35a.9999-3 Q&A 101 allows it to the extent that regulation remains in force.  In practice, it appears, the selling payor will "certify" to acquiring payor that the TINs on the sold/transferred accounts are accurate.  In light of current financial accounting standards that require disclosure of certain liabilities, financial services payors often need to reevaluate the industry practice since the regulation is not clear.

Many financial institutions are now choosing to undertake the costly and time-consuming expense of resoliciting Forms W-9 from the holders of the accounts that the payor has acquired.  This action protects a financial institution from (a) making a tax liability disclosure that will negatively impact its financial statements, and (b) taking the risk that industry practice could be challenged in the future, thus subjecting the entity to IRS penalties and other accounting regulatory penalties.

Other Consideration:

If guidance is issued, the B and C Notice requirements to the acquiring entity will be affected.  If a Form W-9 is not required to be resolicited, does the acquiring payor "step into the shoes" of the selling payor?

Recommendation

We recommend that guidance is published, whether via an IRS Notice or through the forms and instructions, so that payors have a clear understanding of their responsibilities when accounts receiving dividends and/or interest are acquired.

We suggest that the guidance provide that:

  1. A certified TIN is not required to be resolicited by the acquiring payor;
  2. The selling payor provides the acquiring payor written notification of (a) all pre-1984 accounts and their corresponding TINs, and
    (b) all post-1983 accounts and corresponding TINs;
  3. With respect to B and C Notices, the acquiring payor "steps into the shoes" of the selling payor with respect to B and C Notice history.  The selling payor will provide the acquiring payor with the first and second B Notice history for each acquired account to enable the acquiring payor to properly use the 2 in 3 rule; and
  4. With respect to post-acquisition B and C Notices, the selling payor is not required to forward B and C Notices received to the acquiring
    payor.  Consideration should be given to the responsibilities of the selling payor when B and C Notices are received around the effective date for an acquisition.

IRS Response / Action

The IRS understood the need for clarification and offered good suggestions on ways to clarify the issue.  IRPAC was requested to submit a formal request to have the resolicitation issue added to the IRS' Guidance Priority List, which IRPAC did in April 2008.

C. Procedures for complying with Second B Notices appear outdated and should be coordinated with the Social Security Administration’s current policies.

Discussion

Payees are experiencing unnecessary burdens and delays when attempting to comply with IRS mandated procedures for resolving B Notices.

When a payer receives two B Notices within a three year period (referred to as a “Second B Notice”) with respect to the same payee, the payer is required to perform the following functions:

  1. Send the Second B Notice to the payee within 15 business days after receiving notification from IRS;
  2. Inform the payee to have his or her social security number validated on Form SSA-7028 , and have the SSA send the completed Form SSA-7028 to the payer; and
  3. Commence backup withholding within 30 business days after the date of Second B Notice if the payer does not receive Form SSA-7028 from the SSA.

Payees are consistently reporting undue hardship with the requirement that SSA send Form SSA-7028 to payers in a timely manner to resolve their B Notices.  The inability to timely resolve B Notices via Form SSA-7028 is causing excessive backup withholding and financial hardship to payees that are attempting in good faith to comply with the B Notice rules promulgated by the IRS.  During our interviews with IRS personnel, there appeared to be an inconsistency between the expectations of the IRS and the ability of the SSA to execute the Form SSA-7028 procedure in a timely manner to resolve Second B Notices.

Recommendation

IRPAC recommends that the IRS more closely coordinate B Notice procedures with the SSA.  IRS should validate, at least annually, that all SSA field offices are prepared to process requests to issue Form SSA-7028 in a timely manner.  IRS should also consider allowing payers to rely on alternative documentation issued by SSA to prevent or cease backup withholding due to a Second B Notice.  IRS should commence a dialogue with SSA as soon as possible to make certain that SSA is prepared to process requests to issue Form SSA-7028, and to study whether alternative documentation issued by SSA would be suitable for resolving Second B Notices.

IRPAC notes that the procedures for handling B Notices are generally working well.  Final regulations on B Notice procedures were issued on April 10, 1992, and then subsequently modified on April 28, 2003 .  The procedure for resolving Second B Notices with a Form SSA-7028 from the SSA dates back to an agreement reached with the SSA in 1991.   

Since 17 years have lapsed since that agreement has been reached with the SSA, it is appropriate at this juncture to validate that the Form SSA-7028 procedure is operating as expected, and to increase coordination with SSA to make certain that the procedure operates well on an ongoing basis.

D. Reporting Nonqualified Deferred Compensation Benefits Following Employee’s Death

Discussion

There are conflicting directions with respect to distributions from a nonqualified deferred compensation plan after the death of an employee.  Such amounts paid after death are clearly wages (although not subject to income tax withholding).  These distributions should be treated exactly like wages paid after the death of an employee as discussed in the instructions to Form W-2 and Form 1099-MISC.  However, the instructions to Form 1099-R indicate that distributions after death from nonqualified deferred compensation plans should be reported on Form 1099-R.  The 1099-R reporting creates confusion surrounding Code section 3405 withholding and rollover treatment, neither of which applies to these distributions.  Taxpayers would benefit from instruction changes to clarify the 1099-MISC and W-2 reporting of nonqualified deferred compensation plan distributions after death. 

A report was published by IRPAC in 1998 on this very issue.  As explained in that report, Rev. Rul. 86-109 is the cited authority for information reporting of death benefits and compensation payments made after an employee’s death, even though there have been numerous law and forms changes since its issuance in 1986.  Before 1992, employers were required under Rev. Rul. 86-109 to report payments of wages or other regular compensation of a deceased employee to the employee’s estate or beneficiary in

Box 7 of Form 1099-MISC, whether the payments were made in the calendar year of death or in a subsequent year.  Although income tax reporting is still required on Form 1099-MISC, the specifics of how to do it, as set forth in Rev. Rul. 86-109, were overridden by the instructions to the 1992 version of Form 1099-MISC, which required the payments to be reported in Box 3 .  

Rev. Rul. 86-109 is also cited as the authority for the Form 1099 series’ instructions that distributions from nonqualified deferred compensation plans must be reported on Form 1099-R, even though nonqualified deferred compensation payments are wages and would never be reported on Form 1099-R before the employee’s death.  Consistent with the treatment of post-death wages, these payments should be reported on Form 1099-MISC.  Payers report that the recipients of Forms 1099-R issued with respect to nonqualified plan distributions often erroneously conclude that these amounts qualify as eligible rollover distributions.  

This IRPAC recommendation does not affect the FICA treatment of nonqualified deferred compensation plan distributions.  Rev. Rul. 86-109 continues to be correct in its directive that wages or other regular compensation paid in the year of the employee’s death are considered wages for FICA purposes and should be reported on the employee’s final Form W-2.  Whether a post-death nonqualified plan distribution is reported on Form 1099-R or 1099-MISC, it continues to be treated as FICA wages if the distribution occurs in the year of death.  In that case, W-2 reporting is required (in addition to the 1099-MISC reporting) for the FICA wages only.  If the distribution occurs in a year subsequent to the year of death, no W-2 reporting is required.  

The payer community will benefit from this instructions change by gaining a clear understanding of their reporting obligations as they pertain to post-death wage payments, including nonqualified deferred compensation distributions. 
The recipients of nonqualified deferred compensation distributions will benefit from correct Form reporting and a better understanding of the ramifications (employment tax, withholding rules, and ineligibility for rollover treatment) of the payment of wages.

Recommendation

Eliminate the inconsistency between the instructions for Forms 1099-R and 1099-MISC by clarifying that payments to a death beneficiary from a nonqualified deferred compensation plan are wages and as such are reportable on Form 1099-MISC.  The payments may also be reportable on Form W-2, in accordance with the instructions for Form W-2, if the payment is made in the calendar year of death.

IRS Response / Action

The IRS has indicated that the Instructions to the 2009 Forms will incorporate the suggested changes.

E. Clarification of Form W-9 and the Corresponding Instructions Regarding the Entity Classification Box for Limited Liability Companies

Discussion

The most recent version of the Form W-9, issued in October 2007, requests all limited liability companies ("LLC’s") to designate their entity types.  The Form W-9 now provides a specific entity box for an LLC and a tax classification letter ("D" for disregarded entity, "C" for corporation, and "P" for partnership). 

For an LLC classified as a partnership or a corporation, the instructions for completing the form are clear.  The LLC’s name goes on the “Name” line and the taxpayer checks the LLC box with the appropriate tax classification (“P” or “C”). 
The rules are clear for an LLC that is disregarded for tax purposes as long as the ownership structure is simple.  Per the “LLC” instructions, the taxpayer should enter the owner’s name on the “Name” line and the disregarded LLC’s name on the “Business Name” line.  The instructions also state that the taxpayer should enter the owner’s SSN (or the employer identification number ("EIN") of the owner), not the LLC, on the form.    The "Note" in the instructions seems to imply that the owner should check an entity box because it states, "You are requested to check the appropriate box for your status (individual/sole proprietor, corporation, etc.).”  The instructions, however, do not clearly state which entity box (or boxes) should be checked when the LLC is disregarded.  Does the owner designate its status or should the LLC's status be designated?  The current instructions direct the person completing the form to check the LLC box and to write in the code “D” for the tax classification.

Proper completion of the Form W-9 with complex ownership structures becomes more problematic, for example, consider where the single owner of a disregarded LLC is another LLC that is a partnership or corporation for

U.S. federal income tax purposes.  Following the current instructions, it would be correct for the taxpayer to select either the owner-LLC’s tax classification or that of the disregarded LLC.  This leaves the payor unable to determine if the entity classification marked on the form applies to the owner-LLC or the disregarded LLC. 

Recommendation

Taxpayers need expanded guidance on how the Form W-9 should be completed for disregarded LLC’s, which will allow payors to more easily determine whether the forms are valid with respect to the entity on the "Name" line.  IRPAC submitted the following suggestions to the IRS:

  1. On the Form W-9 eliminate the “D” code for LLC’s since the entity (the owner) providing and signing the form should not be a disregarded entity.
  2. Revise the instructions to provide specific guidance on how to complete the form for an entity that is a "sole proprietor", "LLC with 2 or more members", "single-member LLC treated as a corporation", "disregarded single member LLC with a domestic owner", "disregarded single-member LLC with a foreign owner" and "other entities".
  3. In accordance with the above point, the "Specific Instructions, Name, section on Page 2 of the Form W-9 instructions could be revised as follows:

Specific Instructions
Name

If you are an individual, you must generally enter the name shown on your income tax return. However, if you have changed your last name, for instance, due to marriage without informing the Social Security Administration of the name change, enter your first name, the last name shown on your social security card, and your new last name.

If the account is in joint names, list first, and then circle, the name of the person or entity whose number you entered in Part I of the form.

Sole proprietor.  Enter your individual name as shown on your income tax return on the “Name” line. You may enter your business, trade, or “doing business as (DBA)” name on the “Business name” line.

Limited liability company (LLC).  An LLC with 2 or more members may be treated as a corporation or a partnership; and an LLC with a single member may be treated as a corporation or an entity disregarded from its owner.

LLC With 2 or More Members.  If the LLC is domestic and has two or more members, check the “Limited liability company” box only and enter the appropriate code for the tax classification ( “C” for corporation, or  “P” for partnership) in the space provided.  Provide the taxpayer identification number of the LLC.  If the LLC is foreign and has two or more members, do not use Form W-9.  Instead use the appropriate Form W-8 (see Publication 515.)

Single-Member LLC Treated as a Corporation.  For a domestic single-member LLC that has elected to be treated as a corporation, check the “Limited Liability Company” box only and enter “C” for corporation in the space provided.  Provide the taxpayer identification number of the LLC. If the LLC is foreign and treated as a corporation, do not use Form W-9.  Instead use the appropriate Form W-8 (see Publication 515.)

Disregarded Single Member LLC With Domestic Owner.  For a single-member LLC (including a foreign LLC)  with a domestic owner that is disregarded as an entity separate from its owner under Regulations section 301.7701-3, enter the owner’s name on the “Name” line.  Enter the LLC’s name on the “Business name” line.  Check the box appropriate to the owner’s classification, and provide the owner’s taxpayer identification number.

Disregarded Single-Member LLC With Foreign Owner.  For a single-member LLC with a foreign owner that is disregarded as an entity separate from its owner under Regulations section 301.7701-3, do not use Form W-9.  Instead use the appropriate Form W-8 (see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities).

If the LLC (or its single owner) is classified as a corporation, also check the “Exempt Payee” box if applicable for the type of payments the LLC will receive (such as interest and dividends) and refer to the Exempt Payee instructions below.

Other entities.  If not specifically listed, check the “other“ box and enter the type of entity in the blank space.  Enter your business name as shown on required federal tax documents on the “Name” line. This name should match the name shown on the charter or other legal document creating the entity. You may enter any business, trade, or DBA name on the “Business name” line.

IRS Response / Action

The IRS understood the need for clarification, offered suggestions on ways to clarify the instructions and is considering incorporating the suggestions noted above when Form W-9 is next revised; with the exception of item 1 (to eliminate the “D” code for LLC’s) citing disregarded as one of three possible tax classifications for an LLC and the benefit to small business payer/filer community.

 

Page Last Reviewed or Updated: 25-Jun-2013