Backup Withholding requires a payer to “withhold tax” from payments that are not otherwise subject to withholding. A Taxpayer (payee) may be subject to Backup Withholding if it:
• fails to provide a correct taxpayer identification number (TIN) when required, OR
• fails to report interest, dividend, or patronage dividend income.
A payer must withhold at a flat 24% rate. The 24 % tax is taken from any future payments to ensure the IRS receives the tax due on this income.
Backup Withholding is tied to Forms 1099 – a/k/a – “Information Returns”
Forms 1099 is a series of information returns which reports the various types of income a Taxpayer might receive other than what a Taxpayer receives from an Employer (usually a W-2). Financial Institutions and other types of businesses that make certain types of payment to a Taxpayer must file an information return with the IRS (on Form 1099) showing payments that a Taxpayer received during a year. Form 1099 includes a Taxpayer’s name and TIN such as a social security number (SSN), employer identification number (EIN), or individual taxpayer identification number (ITIN).
Payers have the responsibility to obtain Form W-9 (Request for Taxpayer Identification Number and Certification) from a U.S. person (including a resident alien), that includes a Taxpayer’s correct TIN.
Backup withholding may apply to most kinds of payments reported on Form 1099, including:
- Interest payments
- Rents, profits, or other income
- Commissions, fees, or other payments for work performed as an independent contractor
- Payments by brokers and barter exchange transactions
- Payment Card and Third-Party Network Transactions
- Royalty payments
- Payments by fishing boat operators
- Gambling winnings that aren’t subject to regular gambling withholding
Who is Not subject to Backup Withholding?
A Taxpayer will NOT be subject to backup withholding on payments if a Taxpayer:
- provides the requester a correct TIN,
- makes the proper certifications, and
- reports all their taxable interest and dividends on their tax return.
Who is subject to Backup Withholding and the Payer must withhold at a flat 24% rate:
A Taxpayer will be subject to a flat 24% withholding if:
- Taxpayer does not provide the payer their TIN in the required manner
- IRS notifies the payer that the TIN a Taxpayer provided is incorrect
- IRS notifies the payer to start withholding on interest or dividends because a Taxpayer has underreported interest or dividends on their income tax return. The IRS will do this only after it has mailed a Taxpayer four notices over at least a 120-day period.
- Taxpayer fails to certify that they are not subject to backup withholding for underreporting of interest and dividends.
Payments excluded from Backup Withholding
- Real estate transactions
- Foreclosures and abandonments
- Cancelled debts
- Distributions from Archer MSAs
- Long term care benefits
- Distributions from any retirement account
- Distributions from an employee stock ownership plan
- Fish purchases for cash
- Unemployment compensation
- State or local income tax refunds
- Qualified tuition program earnings
Don’t be a Victim of your Own Making
A Taxpayer may only avoid backup withholding if they are able to correct the reason why they became subject to a backup withholding in the first place. This can include:
• providing the correct TIN to the payer,
• resolving the underreported income and paying the amount owed, or
• filing the missing return(s), as appropriate.
Consult your tax specialist for assistance.