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Backup Withholding in the Context of Form W-9

Backup withholding is a critical tax mechanism designed to ensure the collection of taxes on certain types of income. It is particularly relevant in the context of Form W-9, which is used to collect the taxpayer identification number (TIN) and other information from U.S. persons (including resident aliens) to report various types of income to the IRS. Here’s a detailed look at backup withholding as it relates to Form W-9:

What is Backup Withholding?​

Backup withholding is a type of federal income tax withholding that applies to certain payments when the payee fails to provide a correct TIN or has underreported income in the past. The current backup withholding rate is 24% (IRS, NerdWallet).

Payments Subject to Backup Withholding​

Backup withholding can apply to a wide range of payments reported on Form 1099, including:

  • Interest payments
  • Dividends
  • Commissions, fees, and other payments for work performed as an independent contractor
  • Rents
  • Royalties
  • Payments by brokers/barter exchanges
  • Payment card and third-party network transactions
  • Gambling winnings
  • Original issue discount
  • Patronage dividends
  • Payments by fishing boat operators (IRS, Investopedia).

Payments Excluded from Backup Withholding​

Certain types of payments are not subject to backup withholding, such as:

  • Real estate transactions
  • Foreclosures and abandonments
  • Cancelled debts
  • Distributions from Archer MSAs
  • Long-term care benefits
  • Distributions from retirement accounts
  • Distributions from employee stock ownership plans (ESOPs)
  • Fish purchases for cash
  • Unemployment compensation
  • State or local income tax refunds
  • Qualified tuition program earnings (IRS, Community Tax).

When is Backup Withholding Required?​

Backup withholding is required in the following situations:

  1. Incorrect or Missing TIN: If the payee does not provide a TIN, provides an incorrect TIN, or fails to certify the TIN when required (IRS).
  2. IRS Notification: If the IRS notifies the payer that the payee has underreported interest or dividend income, or if the payee has been notified that they are subject to backup withholding due to previous underreporting (IRS).
  3. Failure to Certify: If the payee fails to certify that they are not subject to backup withholding on Form W-9 (IRS).

How to Avoid Backup Withholding​

To avoid backup withholding, payees should:

  • Provide a correct TIN on Form W-9.
  • Ensure that the name and TIN combination matches IRS records.
  • Certify that they are not subject to backup withholding by completing the certification section of Form W-9.
  • Report all taxable interest and dividend income accurately on their tax returns (IRS, Investopedia).

Exemptions from Backup Withholding​

Certain payees are exempt from backup withholding, including:

  • Tax-exempt organizations under section 501(a)
  • The United States or any of its agencies or instrumentalities
  • States, the District of Columbia, U.S. possessions, or their political subdivisions or instrumentalities
  • Foreign governments or their political subdivisions, agencies, or instrumentalities
  • International organizations or their agencies or instrumentalities
  • Corporations (for certain payments such as interest and dividends) (IRS, Fidelity).

Responding to IRS Notices​

If a payer receives a CP2100 or CP2100A Notice from the IRS indicating a problem with the TIN on the information returns filed, the payer must:

  1. Send a "B" Notice: Notify the payee and request a correct TIN using Form W-9.
  2. Begin Backup Withholding: If the payee does not respond with a correct TIN within 30 days, the payer must begin backup withholding at a rate of 24% (IRS).

Reporting and Paying Backup Withholding​

Payers must report backup withholding on:

  • Form 1099-NEC (Nonemployee Compensation) in box 4 (Federal income tax withheld)
  • Form 945 (Annual Return of Withheld Federal Income Tax) (IRS).

Backup withholding amounts must be deposited with the IRS on a monthly or semiweekly basis, depending on the payer’s deposit schedule (IRS).

Conclusion​

Backup withholding is an essential tool for the IRS to ensure that taxes are collected on certain types of income. By understanding the requirements and properly completing Form W-9, payees can avoid backup withholding and ensure compliance with tax regulations. Payers must be diligent in requesting and verifying TINs to avoid penalties and ensure accurate tax reporting.

Tips for Avoiding Backup Withholding​

Provide Accurate Information
  • Ensure that the TIN you provide on Form W-9 is accurate and matches IRS records.
  • Complete all required fields on Form W-9 correctly to avoid mistakes that could trigger backup withholding.
Certify Correctly
  • Always certify that you are not subject to backup withholding by completing the certification section of Form W-9 accurately.
  • Regularly update your information with the IRS to avoid discrepancies.

References​