What the Heck is Backup Withholding?

part of tax return-What the Heck is Backup Withholding

If you are a taxpayer receiving certain types of income payments, the IRS requires the payer of these payments to report them on an information return. The person or business paying you does not generally withhold taxes from these types of payments, as it is assumed you will report and pay taxes on this income when you file your federal income tax return.

So, what the heck is Backup Withholding?

The tax withholding of federal income taxes on income typically does not require tax withholding. However, although some types of income usually do not have taxes withheld, some situations may require that payers withhold a portion of their payments to you.

  • It only applies to certain types of 1099 or gambling income in specific circumstances.
  • It is a method the IRS uses when taxpayers who earn self-employment, gambling, or interest income have not adequately reported it in the past. In these cases, businesses and financial institutions withhold a flat 24% of income as backup withholding. This may apply to you if:
    • You have failed to provide the payer with an accurate taxpayer identification number (TIN). This is often a Social Security number.
    • The Internal Revenue Service (IRS) notifies you that the TIN you provided is not correct.
    • You have under-reported interest or dividends on income tax returns in the past. However, you will get four warnings from the IRS before this applies to you.
    • You fail to certify that you are not subject to backup withholding due to under-reported interest or dividends.
  • It generally only applies to certain types of 1099 income, including:
    • Interest
    • Dividends
    • Patronage dividends
    • Rents
    • Gambling winnings
    • Royalties
    • Commissions and fees paid to independent contractors
    • Payments from brokers on stock and bond transactions
    • Payments from fishing boat operators

Payments that are not subject to mandatory withholding include canceled debts, real estate transactions, retirement account distributions, and unemployment compensation.

Okay, So, Just How Does Backup Withholding work?

The process for initiating backup withholding depends on why the IRS requires it in the first place.

  • Withholding Due to Incorrect Information
    • Backup withholding due to submitting an incorrect name, SSN, or ITIN on Form W-9 can be prevented or stopped by supplying your payer with corrected information on Form W-9 as soon as possible.
    • If it cannot match the name and ITIN information you provided on your W-9, the IRS will send a notice—called a “B” notice—to the payer, alerting them that the ITIN or the SSN they’re using does not coincide with IRS records. The payer should send a copy of the “B” notice to you before it begins backup withholding.
    • The payer is prohibited from simply calling you and requesting the correct information by phone. They might also request verification of the right information, such as a Social Security card.
    • Supplying the correct information to the payer can stop backup withholding if it’s already begun.
  • Withholding Due to Unreported Interest or Dividends
    • In the case of unreported (or under-reported) interest or dividends, the IRS will notify you by mailing four notices over 210 days to alert you of future backup withholding. You can ask the IRS not to resort to backup withholding or to stop it after it’s begun, but you must establish that one of four acceptable circumstances exists:
      • You did not under-report interest or dividends earned.
      • You have reached out to the IRS about whether an under-reporting occurred, but the matter has not been resolved yet.
      • It will create an undue hardship for you, and it’s unlikely that you will under-report interest and dividends in the future. (In other words, it was an honest error, and you need the money withheld from you.)
      • You’ve either filed an amended return that correctly reports all interest and dividends (as well as paying taxes, penalties, and interests due) or filed an original return reporting the income (if you didn’t previously file one).
      • The IRS will provide you with certification and will notify any payers who were sent notices if it determines that backup withholding isn’t required or that it should stop.

Can Backup Withholding Be Recovered?

  • It is a precaution, as the name suggests. It’s not so much a penalty as a way the IRS can ensure that you ultimately pay all taxes that are due.
  • You will be notified of any federal income tax withheld due to backup withholding, and the IRS will correct the form. You can then report the amount as taxes withheld when you file your tax return. You would receive a refund at tax time if you had more taxes withheld than what you owe.
  • Partnerships and S corporations cannot claim a refund for overpaid backup withholding. Instead, the refund must be claimed by the partners or shareholders.

Who Is Exempt from Backup Withholding?

  • U.S. citizens and resident aliens are exempt from backup withholding if they properly report their names and Social Security numbers or ITINs to the payer using Form W-9 and if that information matches IRS records.
  • They’re also exempt if the IRS has explicitly notified them that they’re not subject to mandatory backup withholding for some reason.

The IRS can require taxpayers to take backup withholding from certain self-employments, interest, rental, and gambling income if the taxpayer fails to provide correct information.

Provide all payers with the correct name and taxpayer identification number (ITIN) and accurately report all interest and dividend income. Then, you should not have to have backup withholding taken from your income.

As with other tax withholding, you can receive a refund for any overpaid amounts.

Most taxpayers are not subject to backup withholding.

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