What Is Federal Backup Withholding and How to Stop It?

Federal backup withholding is a mechanism that requires payers to withhold a flat-rate tax from certain payments. This process ensures the Internal Revenue Service (IRS) collects taxes on income that might otherwise not be reported. When specific conditions are not met by the recipient of the payment, the entity making the payment is obligated to deduct and send a portion of the payment directly to the IRS.

Triggers for Backup Withholding

Backup withholding is initiated by specific failures on the part of the payment recipient. The most common trigger is the failure to provide a valid Taxpayer Identification Number (TIN) to the payer. A TIN can be a Social Security Number (SSN) for an individual or an Employer Identification Number (EIN) for a business.

Another cause is providing an incorrect TIN. If the name and TIN combination submitted does not match IRS records, the payer will be notified to begin withholding. This notification often comes via an IRS notice that identifies the mismatch.

The IRS itself can instruct a payer to start backup withholding, which can happen if a taxpayer previously underreported interest or dividend income. The IRS will send multiple notices to the taxpayer before instructing the payer to begin withholding at a rate of 24%.

A final trigger is the failure to properly certify your status on Form W-9, Request for Taxpayer Identification Number and Certification. On this form, you must certify that you are not subject to backup withholding. If you fail to make this certification, the payer is required to begin withholding.

Payments Subject to Backup Withholding

A wide range of payments can be subject to backup withholding, primarily those reported on Form 1099. These include interest payments (reported on Form 1099-INT) and dividends (Form 1099-DIV). When you open a bank or investment account, providing a correct TIN is necessary to avoid withholding on these earnings.

Payments made to independent contractors, reported on Form 1099-NEC, are also covered. Other types of income, such as rents, royalties, and commissions (Form 1099-MISC), also fall under these rules.

Transactions involving brokers (Form 1099-B) and certain government payments or gambling winnings (Form W-2G) can also trigger backup withholding. However, many government-related payments are exempt, including unemployment compensation, state or local tax refunds, and distributions from retirement accounts. Wages and salaries, which are already subject to regular payroll tax withholding, are also excluded.

How to Stop Backup Withholding

Stopping backup withholding requires correcting the specific issue that caused it to start. If withholding was initiated due to a missing or incorrect TIN, or because you failed to certify your status, the solution is to provide the correct information to the payer. This is done by completing a Form W-9 with your accurate name and TIN and submitting it to the entity that makes the payments.

Once the payer receives the corrected Form W-9, they will update their records and cease backup withholding on future payments. The payer will continue to withhold from each payment until they receive the updated information.

If the withholding was triggered by an IRS notification regarding underreported income, the process is more involved. You must resolve the underlying tax issue directly with the IRS. This may require filing an amended tax return to report the correct income and paying any associated tax, interest, and penalties. After the matter is settled, the IRS will notify the payer that they can stop withholding.

Claiming Withheld Amounts on Your Tax Return

Even if you were subject to backup withholding, the money is not lost, as it is treated as a payment of federal income tax. When you file your annual income tax return, you can claim credit for these amounts. The total federal income tax withheld will be reported to you by the payer on an information return, such as a Form 1099-NEC or 1099-MISC.

The withheld amount is typically shown in Box 4 of the relevant Form 1099 and must be reported on your Form 1040, U.S. Individual Income Tax Return. You will include this amount on the line for “Federal income tax withheld from Forms W-2 and 1099.”

This total withheld amount is then credited against your total tax liability for the year. If the amount of tax withheld is more than the total tax you owe, you will receive a refund. If the withheld amount is less than your total tax liability, it will reduce the amount you have to pay.