What Is Backup Withholding and How Do You Stop It?

Backup withholding is a federal requirement designed to ensure the Internal Revenue Service (IRS) collects income tax on certain payments not typically subject to regular payroll withholding. It acts as a safety net, applying to specific income streams to prevent underreporting of taxable earnings.

Overview of Backup Withholding

Backup withholding is a tax collection method where a payer, such as a bank or business, deducts a percentage of certain payments made to an individual and sends it directly to the IRS. This differs from standard employment withholding, where an employer withholds taxes from an employee’s wages.

As of 2024, the backup withholding tax rate is 24% of the reportable payment. This fixed rate applies regardless of the recipient’s tax bracket or other income. The payer is responsible for withholding these funds and remitting the collected amount to the IRS. The payer also reports the payment and the withheld amount on an IRS information return, such as Form 1099, and provides a copy to the recipient.

Reasons for Backup Withholding

Several specific circumstances can trigger backup withholding. One common reason is the failure to provide a correct Taxpayer Identification Number (TIN) to the payer. A TIN can be a Social Security Number (SSN), Employer Identification Number (EIN), or Individual Taxpayer Identification Number (ITIN). Without a correct TIN, the payer cannot properly report the income to the IRS.

Backup withholding can also occur if the IRS notifies the payer that the TIN provided by the payee is incorrect. This mismatch between the information submitted by the payer and IRS records can lead to the imposition of withholding. The IRS may also instruct a payer to begin backup withholding on interest or dividend payments if a taxpayer has previously underreported such income on their tax return.

A final trigger is the failure to certify that one is not subject to backup withholding for underreporting of interest and dividends. This certification is often required on forms like Form W-9. If the payee does not provide this certification when requested, the payer is required to begin withholding.

Income Subject to Backup Withholding

Backup withholding can apply to various types of income payments, particularly those not subject to regular employment withholding. These include:

• Interest payments (Form 1099-INT)
• Dividend payments (Form 1099-DIV)
• Rent and royalty payments, as well as other gains (Form 1099-MISC)
• Payments for services performed as an independent contractor, including commissions and fees (Form 1099-NEC)
• Broker and barter exchange transactions (Form 1099-B)
• Certain government payments (Form 1099-G)
• Patronage dividends (if at least half the payment is in money) (Form 1099-PATR)
• Payments made through payment card and third-party networks (Form 1099-K)

Resolving and Avoiding Backup Withholding

Stopping existing backup withholding and preventing it in the future requires specific actions, often beginning with addressing the notification received. If you receive a notice from a payer or the IRS indicating you are subject to backup withholding, the first step is to identify the reason provided in the notice. This often involves a missing or incorrect Taxpayer Identification Number (TIN), or a notice from the IRS about underreported interest or dividends.

The primary document used to resolve most backup withholding issues is IRS Form W-9, Request for Taxpayer Identification Number and Certification. You must accurately complete this form, ensuring your name and TIN match the records of the Social Security Administration (SSA) or the IRS. For individuals, this means providing your correct Social Security Number (SSN). If you are a sole proprietor, list your name on line 1 and use your SSN, while a business entity would list its name and provide its Employer Identification Number (EIN).

Part I of Form W-9 requires you to enter your name and the appropriate TIN. If you are a new business and have applied for a TIN but not yet received it, you can write “Applied For” in the TIN box, but you must provide the number as soon as possible to avoid continued withholding. For interest and dividend payments, and certain payments with readily tradable instruments, you have 60 days to provide your TIN before withholding begins.

Part II of Form W-9 contains certifications that you must sign. This section requires you to certify that the TIN provided is correct, that you are not subject to backup withholding due to underreported interest or dividends, or that the IRS has notified you that you are no longer subject to it. If you have been notified by the IRS that you are currently subject to backup withholding for underreporting interest and dividends, you must cross out item 2 of the certification.

Once you have completed and signed Form W-9, you must submit it to the payer who is withholding funds. You deal directly with the payer, not the IRS, to stop the withholding. The payer is required to stop backup withholding within 30 calendar days after receiving the correct certification or TIN validation. Maintaining accurate records of all income, providing correct TINs to all payers, and properly reporting all taxable income on your federal tax return are the most effective ways to prevent future backup withholding.