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Best practices for businesses to meet vendor compliance requirements

7 min read
Alan Ruttenberg

It’s a reality of the modern economy that many businesses from small to large now depend on the services of vendors, contractors, agencies, marketplace sellers, and freelancers. Their labor isn’t likely to outlive their usefulness anytime soon and that means businesses will continue to depend upon their services. 

A reactive approach to the tax rules governing their payments can result in myriad penalties from B-notices (A 1099 B Notice is when the IRS notifies the 1099 filer that a name and taxpayer identification number (TIN) don't match the IRS database.) and payment withholdings to expensive litigation with the IRS. Moreover, even businesses that avoid getting caught by the rules and regulations can inadvertently find themselves dealing with manual paperwork and rigidly designed processes.  

At the heart of this issue is one of the most common mistakes that even seasoned tax professionals are prone to make – they think of compliance with respect to payments to vendors as a seasonal challenge that culminates before the IRS’ strict January deadline rather than as a year-round issue. The idea that a business can quickly tackle vendor tax compliance in the days before a deadline is a tempting fallacy, but it leads to complications when the right documents, signed by the right party, aren’t in place at the right time.  

In this blog post, tax experts at Avalara will offer four best practices for handling vendor tax compliance based on their multi-year experience providing 1099 solutions to tens of thousands of companies, but first level-set with specific definitions.

Disclaimer: This content should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.

Vendor tax compliance terminology

The IRS Form W-9 is used to request the correct Taxpayer Identification Number (TIN) from a vendor, company, or individual for which non-employee income was or will be paid during a calendar year.

The IRS Form 1099 is filed annually with the IRS to report non-employee payments to the vendor and should utilize the information collected in a W-9. The 1099 is required if the vendor, company, or individual receives payment for services throughout the calendar year. There are many variations of the 1099, ranging from the common 1099-NEC which is standard for non-employee compensation to less common variations such as the 1099-SB which exists for the selling of life insurance contracts.  

4 best practices for businesses to meet vendor compliance requirements

Now for our best practices. 

1. Collect W-9s at the point of hiring

Nothing is technically “due” at the point of onboarding a new vendor; nobody typically audits a business on the spot every time. But it’s nevertheless essential to collect W-9s right away and store them securely.  

(About secure storage – the W series of IRS forms typically contain social security numbers. You are now a custodian of these numbers and that means security protocols matter a great deal. A hacked computer or similar data breach can result in costly litigation. Keep your IT department in the loop and make sure their security protocols are up to the task.)  

Eventually, the information contained within the W-9s that you collect from vendors throughout the year will become the basis of the 1099s that you must file in January. You will also need to save your W-9s in the event of an audit. The IRS official guidelines recommend keeping them (once again in a safe and secure manner) for five years.  

2. Prepare for unexpected IRS rule changes

The recent saga of the 1099-K is a telling example that demonstrates the need to conduct due diligence throughout the calendar year so as not to get caught unaware by IRS rule changes.  

The 1099-K is used to report debit and credit card transactions from third-party network payments. It’s required of marketplace sellers, but only if they meet a minimum threshold. In preparation for the 2024 filing season, the IRS reduced the 1099-K threshold for requiring a 1099 from $20,000 to $600.  The new rules raised many eyebrows in the online marketplace community as they scrambled to get ahead of the new regulations.  

When Avalara conducted research to gauge sentiments among marketplace sellers, they found that 55% of respondents saw the 1099-K reporting threshold change as a potential barrier to continuing marketplace selling or gig work. Meanwhile, 83% of marketplaces anticipated some sellers to drop from the platforms because of the complexity inherent in the 1099-K changes.*  

In the background, members of Congress were concerned about the impact on small businesses and proposed legislation called the Red Tape Reduction Act to raise the threshold back to $10,000, but it didn’t move quickly. Marketplaces and their sellers had to wait and see. That is until November 2023 when the IRS acted on their own, delaying the reduction in the 1099-K threshold until tax year 2024.​  

With such fluctuations in the rules, it’s hard for a business owner to maintain confidence that they know what they need to know. What they heard in the spring, simply may not still be applicable in the fall or winter. It’s imperative to find reputable sources of information.  

3. Know what your state requires of you

It’s not just the IRS. Individual states have their own compliance and taxation rules. They sometimes require filings as well. It’s important to consider the following examples: 

  • California requires direct filing of forms 3921/3922 even if you participate in the Combined Federal/State Filing Program.  
  • Although Oklahoma’s website lists the Combined Federal/State Filing Program as an acceptable option for filing 1099s, the 1099-NEC is not included and must be filed directly.  
  • According to the South Carolina rules, if any state income tax was withheld, 1099s must be burned to a CD-ROM in the antiquated IRS format and mailed to the Dept of Revenue.  

It can’t be said often enough that due diligence is the only way to understand what is required of you and by whom.  

4. Work electronically  

At Avalara, we’ve encountered businesses who have spent over $400 in printing costs and accumulated many hours of labor just to obtain W-9s from the vendors, get their 1099s filed to the IRS, get copies sent back manually to their vendors, and then correct errors in social security numbers and legal names once they get flagged by the IRS. It’s unfortunate because these are the pain points associated with cumbersome processes that a well-designed 1099 software application can alleviate through automation. For example, the right software should:

  • Make it possible to request W-9s via electronic transmission from vendors and require that they sign a consent agreement in the process so that they can receive their 1099s back electronically as well.  
  • E-file with the IRS since they don’t actually require postal mail for their 1099 filings.
  • Proactively keep you informed about which states require 1099 filings too and which ones will accept e-filings and which ones require postal mail. 
  • Cut down on filing errors by checking social security numbers and legal names with the IRS database both at the time of onboarding and at the moment of e-filing just before the January deadline, thereby reducing the potential for mistakes that can result in B-notices and legal penalties. Needless to say, you’d rather catch a potentially costly error with your software instead of letting the IRS do it on your behalf.  

For these reasons among others, automating 1099 compliance with online software can be a considerable savings in both time and money. Getting this right will matter to your bottom line, whether you are a small business owner or tax professional. The responsibility of 1099 compliance isn’t going away, but if you follow these best practices every year, you’ll be better prepared to meet the challenge.  

*Avalara, Avalara Survey Finds Proposed Changes to 1099-K Reporting Threshold Would Have Wide-Reaching Impacts on Marketplace Sellers, Online Marketplaces, and Gig Workers, Nov 28, 2023 (Survey

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