The backup withholding is used by the Internal Revenue Service (IRS) as a tool to ensure the payment of all taxes owed on certain types of income when taxpayers have not reported it correctly in the past, by requiring payers to withhold a portion of their payments for the taxpayer. This applies only in cases where federal tax withholding is not typically required, such as income from Form 1099 or gambling.
How does backup withholding work?
Backup withholding is a method used by the IRS when taxpayers receiving certain income from self-employment, gambling, or interest have not reported it correctly in the past.
How much is the backup withholding and when does it apply?
Businesses and financial institutions withhold a fixed rate of 24% of income as backup withholding for taxpayers subject to the rule. This may apply to you if:
- You failed to provide the correct Taxpayer Identification Number (TIN) to the payer. This is often the Social Security Number.
- The IRS notifies the payer that the TIN you provided is incorrect.
- You submitted previous tax returns that did not report interest or dividends. You will receive four warnings from the IRS before this applies to you.
- You fail to certify that you are not subject to backup withholding due to unreported interest or dividends.
What payments are subject to backup withholding?
Backup withholding mainly applies to certain types of income from Form 1099, including:
- Interest
- Dividends
- Membership earnings
- Rents
- Gambling winnings
- Royalties
- Commissions and fees paid to independent contractors
- Payments from fishing boat operators
What payments are not subject to backup withholding?
There are some types of payments that are exempt from backup withholding, including:
- Real estate transactions
- Seizures and forfeitures
- Cancelled debts
- Long-term care benefits
- Retirement account distributions
- Employee stock ownership plan distributions
- Cash purchases of fish
- Unemployment compensation
- Local or state income tax refunds
- Gains from a qualified educational program
Backup withholding due to incorrect information
Backup withholding due to providing an incorrect name or TIN on Form W-9 can be avoided or stopped by providing the payer with the corrected information on Form W-9 as soon as possible.
The IRS will send a notice, called Notice “B,” to the payer of income if the information regarding the name and TIN you provided on Form W-9 does not match IRS records. The payer must send you a copy of Notice “B” before backup withholding begins.
The payer can request verification or proof of the correct information, such as a Social Security card or a tax return bearing your name and number.
Stopping backup withholding if it has already started can be achieved by providing the correct information to the payer. Even better, avoid any future backup withholding by double-checking all your tax documents before submitting them to anyone who will pay you this type of income.
Backup withholding due to unreported interest or dividends
The IRS will mail out four notices over the course of 210 days to alert you of future backup withholding if you have not reported interest or dividends or have incorrectly reported them. You can request the IRS not to impose backup withholding or to stop it after it has started. However, you must prove that one of the four acceptable circumstances exists:
- You did not report interest or dividends earned. You contacted the IRS about whether there was indeed incorrect reporting, but the issue has not yet been resolved. Backup withholding will cause you undue hardship. It is unlikely you will report future interest and dividends. It was a good-faith error. You need the money that will be withheld from you. You submitted an amended return that correctly reports all interest and dividends (along with paying the taxes, penalties, and interest owed), or you submitted an original return reporting the income if you did not submit a prior return.
Questions
Frequently Asked Questions (FAQs)
Are there any penalties for backup withholding?
Backup withholding is not a penalty as much as it is a means used by the IRS to ensure the payment of all taxes owed. Any federal income tax withheld from your income due to backup withholding will be reported to you and the IRS on the appropriate 1099 form. You may then report the amount as withheld taxes paid when filing your tax return.
Do I need to pay the backup withholding?
Most taxpayers are exempt from backup withholding. U.S. citizens and resident aliens are exempt as long as they report their names and Social Security numbers or Tax Identification Numbers (TINs) to the payer and that information matches the records of the IRS. They are also exempt if they have been notified by the IRS that they are not subject to mandatory backup withholding for some reason.
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Sources:
- IRS. “Topic Number 307 Backup Withholding.”
- IRS. “Backup Withholding.”
- IRS. “Backup Withholding Due to Name/TIN Mismatch or Missing.” Page 11.
- IRS. “Publication 505, Tax Withholding and Estimated Tax.”
Source: https://www.thebalancemoney.com/backup-withholding-3193454
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