What Is Backup Withholding and How Do You Stop It?
Learn what backup withholding is and how to effectively address and prevent this IRS tax issue to ensure proper financial reporting.
Backup withholding is an IRS mechanism to collect taxes on income types that typically do not have tax withheld at the time of payment. It applies to non-employee payments and acts as a safeguard when the payer lacks accurate taxpayer information. This process helps the IRS secure tax revenue that might otherwise go unreported.
What is Backup Withholding
Backup withholding is a specific tax rate, currently 24%, applied to various non-payroll income types. The IRS mandates this withholding, which is taken by the payer and remitted directly to the IRS.
This withholding applies to many income types reported on Form 1099. These include:
Interest payments (Form 1099-INT)
Dividends (Form 1099-DIV)
Payments for services as an independent contractor (Form 1099-NEC)
Royalties
Rents
Certain government payments
Gambling winnings (Form W-2G)
It generally applies to payments made to individuals, partnerships, or S corporations when a correct Taxpayer Identification Number (TIN) is not provided.
When and Why It Occurs
Backup withholding is triggered by situations indicating a potential risk of underreported income. A common reason is a missing or incorrect Taxpayer Identification Number (TIN), such as a Social Security Number (SSN) or Employer Identification Number (EIN), provided to the payer.
Other triggers include a recipient failing to certify that the provided TIN is correct. The IRS can also initiate backup withholding if it notifies the payer that the recipient has underreported interest or dividend income. This can also occur if the recipient fails to certify they are not subject to it due to prior underreporting, or if they fail to respond to an IRS notice about an incorrect TIN.
Providing Correct Information and Certifications
To address or prevent backup withholding, providing accurate information is essential. The primary piece of information required is a correct Taxpayer Identification Number (TIN), which can be an SSN for individuals, an EIN for businesses, or an Individual Taxpayer Identification Number (ITIN). This TIN must precisely match the name on file with the IRS.
The standard method for providing this information is by completing IRS Form W-9. This form can be obtained from the IRS website or directly from the payer. When completing Form W-9, Part I requires entering your name exactly as it appears on your tax return and selecting your correct federal tax classification (e.g., individual, corporation, partnership, or LLC). You must then enter your correct TIN in the designated box; for individuals, this is generally your SSN, while other entities use their EIN.
Part II of Form W-9 requires specific certifications for preventing backup withholding. You must certify that the TIN you provided is correct, or that you are awaiting a new one. Additionally, you generally certify that you are not subject to backup withholding due to underreporting of interest and dividends, or that you are exempt from backup withholding. If you are providing a Form W-9 for interest or dividend payments and have been notified by the IRS that you are subject to backup withholding due to underreporting, you may need to strike out the certification relating to not being subject to backup withholding.
Stopping and Preventing Backup Withholding
Once Form W-9 is completed, submit it to the payer to stop backup withholding. Upon receiving a correct Form W-9, the payer will cease the withholding. The payer will report the tax withheld on your Form 1099 or W-2G, and you can claim this amount as a credit on your federal income tax return.
If backup withholding was triggered by an IRS notice due to underreporting of interest or dividends, resolving the issue may require direct action with the IRS. This could involve filing missing tax returns, amending previous returns to report the income, or paying any tax owed. The IRS sends notices to payers when there are issues with TINs or underreporting, indicating that backup withholding may be required.
To prevent future backup withholding, consistently provide accurate TINs to all payers when opening new accounts or beginning new income streams. Promptly respond to any notices received from the IRS or payers regarding your TIN or income reporting. Maintaining accurate records and ensuring all taxable income is correctly reported on your annual tax return helps avoid these issues.