What Is Backup Withholding and How Does It Work?
Understand IRS backup withholding. Learn what this tax mechanism is, why it might apply to your income, and how it's handled.
Backup withholding is a mechanism used by the Internal Revenue Service (IRS) to ensure tax compliance on specific types of income. It acts as a safeguard, compelling payers to withhold a portion of certain payments and remit it directly to the government. This system helps the IRS collect taxes that might otherwise go unreported or unpaid, particularly on income not subject to standard payroll withholding.
What Backup Withholding Means
Backup withholding is a federal income tax withholding requirement for payments made to individuals or entities that generally do not have taxes withheld. Its primary purpose is to ensure the IRS collects taxes on income that might not be fully reported by the recipient. Unlike the regular income tax withholding applied to employee wages, backup withholding applies to non-employee payments. The current backup withholding rate is 24% of the payment.
Triggers for Backup Withholding
Backup withholding is initiated under specific circumstances that indicate a potential for underreported income. One common trigger occurs when a payee fails to provide a correct Taxpayer Identification Number (TIN), such as a Social Security Number (SSN), Employer Identification Number (EIN), or Individual Taxpayer Identification Number (ITIN), to the payer. This also includes situations where the provided TIN does not match IRS records.
Another trigger is notification from the IRS to a payer that the payee has previously underreported interest or dividend income. Backup withholding can also start if a payee fails to certify, usually on Form W-9, that they are not subject to backup withholding.
Income Subject to Backup Withholding
Backup withholding can apply to various types of income that are typically reported on IRS Forms 1099 and W-2G. Common examples include interest payments, which are reported on Form 1099-INT, and dividend payments reported on Form 1099-DIV.
Other income types subject to backup withholding include payments from broker and barter exchange transactions (Form 1099-B), and certain rents, royalties, or other income reported on Form 1099-MISC. Payments for services performed by a non-employee are also susceptible and are reported on Form 1099-NEC. Gambling winnings can also trigger backup withholding.
Resolving Backup Withholding Issues
To stop or prevent backup withholding, a payee must address the underlying reason for its initiation. If the issue is a missing or incorrect Taxpayer Identification Number (TIN), providing the correct TIN to the payer is the primary step. This often involves completing and submitting a new Form W-9, Request for Taxpayer Identification Number and Certification.
If the IRS has notified the payer about underreported interest or dividends, the payee must resolve the underreporting issue directly with the IRS. This may involve filing amended tax returns or providing documentation to the IRS to demonstrate that the income was correctly reported. Responding promptly to IRS notices is important. Once the issue is resolved and certified to the payer, they will typically cease the backup withholding.
How Backup Withholding is Accounted For
Amounts withheld under backup withholding rules are reported to the payee and the IRS. The payer will include the withheld amount in Box 4 of the relevant IRS Form 1099 (e.g., 1099-INT, 1099-DIV, 1099-MISC, 1099-NEC) or Form W-2G. This reported amount represents federal income tax that has already been paid on behalf of the payee.
When filing an annual income tax return (Form 1040), the payee claims the backup withholding as a credit against their total tax liability. If the amount of tax withheld through backup withholding exceeds the actual tax owed for the year, the payee will receive a refund for the excess amount. Payers must also report these withheld amounts to the IRS using Form 945, Annual Return of Withheld Federal Income Tax.