What Is Backup Withholding From the IRS?

Backup withholding is a mechanism used by the Internal Revenue Service (IRS) to ensure taxes are collected on certain income types that typically do not have tax withheld. It addresses situations where the IRS might not have accurate taxpayer information or income has been underreported. This system helps reduce the tax gap and promotes accurate income reporting and tax compliance.

What Triggers Backup Withholding

Backup withholding is initiated under specific circumstances that signal potential issues with tax reporting or identification. A common trigger is the failure to provide a correct Taxpayer Identification Number (TIN) to the entity making a payment, including a missing, incorrect, or mismatched TIN.

Another trigger occurs when the IRS notifies the payer that the recipient’s TIN is incorrect. These notifications, such as “B notices” or “CP2100/CP2100A notices,” inform both the payer and recipient of the discrepancy. Backup withholding can also be imposed if a taxpayer fails to certify they are not subject to it, a certification often made on IRS Form W-9.

Underreporting of interest or dividend income on a previously filed tax return can also lead to backup withholding. If the IRS identifies that a taxpayer has not accurately reported these income types, they may be subject to this withholding.

How Backup Withholding Works

When backup withholding is triggered, the payer is required to withhold a specific percentage of certain payments made to the recipient. As of 2024, the federal income tax rate for backup withholding is 24%. This amount is then remitted directly to the IRS by the payer.

Backup withholding applies to various income types typically reported on IRS Form 1099. These commonly include interest payments, dividends, payments for services by independent contractors, royalties, rents, and certain gambling winnings.

The payer, such as a bank or brokerage firm, is responsible for implementing this withholding. Before initiating backup withholding, the payer usually sends a notice to the recipient. The payer then sends the withheld funds to the IRS and reports the amount withheld on the appropriate Form 1099.

Stopping Backup Withholding

To stop backup withholding, the first step involves identifying the specific reason it was imposed. This often requires reviewing notices received from the payer or directly from the IRS, such as a CP2100 or CP2100A notice, which indicates an incorrect Taxpayer Identification Number (TIN). Once the issue is identified, specific actions can be taken to resolve it.

If the problem is an incorrect TIN, the taxpayer must provide the correct information to the payer. This process usually involves completing and submitting a new IRS Form W-9. On Form W-9, individuals certify their correct TIN and confirm they are not subject to backup withholding.

In cases where backup withholding was triggered by underreporting interest or dividend income, the taxpayer needs to resolve the discrepancy with the IRS. This may involve filing an amended tax return, such as Form 1040-X, to correctly report the income and pay any additional tax and penalties due. Once the underlying issue is corrected, the payer should cease the withholding. The IRS will also notify the payer to stop if the issue was a direct IRS notification.

Reporting and Refunds

Any income payments subject to backup withholding are reported to the taxpayer on a Form 1099. For example, interest income is reported on Form 1099-INT, dividends on Form 1099-DIV, and non-employee compensation on Form 1099-NEC. A specific box on these forms will indicate the amount of federal income tax withheld due to backup withholding.

When filing an annual federal income tax return, such as Form 1040, the amount of backup withholding shown on the Form 1099 is treated as federal income tax withheld. This reduces the overall tax liability owed by the taxpayer for the year.

If the total amount of backup withholding, along with any other federal income tax withheld or estimated tax payments, exceeds the taxpayer’s total tax liability for the year, the taxpayer will receive a refund. This refund is processed through the normal tax return filing process, similar to any other overpayment of tax. There is no separate or special procedure required to obtain a refund of amounts withheld through backup withholding.