When applicable, backup withholding requires a payer to withhold tax from payments that are not normally subject to withholding. This may apply if an individual fails to provide a correct taxpayer identification number (TIN) when required or does not report interest, dividend, or patronage dividend income.
Banks and other businesses that make certain types of payments must file an information return with the IRS on Form 1099, detailing payments made throughout the year. This form includes the recipient's name and TIN, which could be a Social Security number (SSN), employer identification number (EIN), or individual taxpayer identification number (ITIN). It will also indicate any amounts withheld under backup withholding rules.
Payments Subject to Backup Withholding
Backup withholding can be applied to various types of payments reported on Form 1099, including:
Interest payments (Form 1099-INT)
Certain government payments (Form 1099-G)
Dividends (Form 1099-DIV)
Patronage dividends, if at least half of the payment is in money (Form 1099-PATR)
Rents, profits, royalties, other income, gross proceeds paid to an attorney, and other types of payments (Form 1099-MISC)
Commissions, fees, or other payments for independent contractor work (Form 1099-NEC)
Payments from brokers and barter exchange transactions (Form 1099-B)
Payment card and third-party network transactions (Form 1099-K)
Original issue discount, limited to the amount of cash paid (Form 1099-OID)
Gambling winnings that are not subject to regular gambling withholding (Form W-2G)
Withholding Rules
When opening a new account, making an investment, or receiving payments reportable on Form 1099, individuals must provide their TIN. In some cases, they must submit it in writing and certify under penalties of perjury that it is correct. Financial institutions and businesses will provide Form W-9, Request for Taxpayer Identification Number and Certification, or a similar form for this purpose. If the account or investment earns interest or dividends, the individual must also certify that they are not subject to backup withholding due to prior underreporting.
Backup withholding at a flat 24% rate may be required when:
The individual fails to provide a TIN in the required manner
The IRS notifies the payer that the provided TIN is incorrect
The IRS instructs the payer to withhold on interest or dividends due to underreporting. This occurs only after four notices have been mailed over at least a 120-day period
The individual does not certify that they are not subject to backup withholding for underreported interest and dividends
How to Prevent or Stop Backup Withholding
To stop backup withholding, the issue that triggered it must be resolved. This may involve providing the correct TIN to the payer, addressing underreported income, paying any amounts owed, or filing missing tax returns.
If an individual receives a notice from a payer stating that the TIN provided is incorrect, they can usually prevent or stop backup withholding by providing the correct name and TIN and certifying their accuracy. If a second notice is received from the same payer, further verification of the correct name and TIN is required. More details can be found in Publication 1281, Backup Withholding for Missing and Incorrect Name/TIN(s).
Claiming Credit for Backup Withholding
Amounts withheld under backup withholding rules should be reported as federal income tax withheld on the individual’s tax return for the year in which the income was received.
For partnerships and subchapter S corporations, backup withholding can only be claimed by partners and shareholders. They should report their respective shares of the withheld amounts on their individual income tax returns. These amounts are not refundable to the business entity itself.