What is Backup Withholding?
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Summary:
Backup withholding occurs if the Internal Revenue Service (IRS) suspects that you may have provided inaccurate information or underreported your 1099 or W2-G income for the previous years. To comply with this, your payer withholds 24% of your income to ensure that the IRS receives its share of taxes.
Backup withholding is a tax rate that is mainly levied against investment income to ensure investors who are not subject to tax withholding pay their share of taxes as they withdraw it. The idea is that backup withholding will help the IRS collect taxes owed by reducing the risk of investors spending their income before taxes are due.
To put it simply, this means that a percentage of your investment income will be withheld in case you owe money to the government later on. Backup withholding tax can be a hassle. It’s important to make sure that you’re doing everything right, so that you don’t have to worry about owing the IRS money.
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How does backup withholding work?
When you receive specific types of 1099 or W2-G income, you might be subject to backup withholding where the payer withholds a flat 24% from your income. This could happen if:
- You don’t provide the payer with an accurate tax identification number (TIN).
- The IRS notifies the payer that the TIN you provided isn’t correct.
- You failed to certify that you aren’t subject to backup withholding.
- You’ve underreported interest or dividends on your income tax return in the past. (This will only apply to you after the IRS has mailed you notices four times over at least a 120-day period).
Types of income subject to backup withholding
Most types of income reported on Form 1099 can be subject to backup withholding, including:
- Interest payments
- Dividends
- Payment card or other third party network transactions
- Patronage dividends where at least half of the payment is in cash
- Rents, profits, or other earnings
- Attorney’s fees
- Commissions and fees paid to independent contractors
- Payments from brokers on securities transactions
- Payments from fishing boat operators, but only cash received as a share of the catch
- Royalty payments
- Gambling winnings
Payments that aren’t subject to backup withholding by the IRS include real estate transactions, canceled debts, unemployment compensation, state or local income tax refunds, etc.
If you aren’t sure whether you’re subject to backup withholding or not, consult with a tax professional or visit the IRS website.
How did I incur backup withholding?
The IRS often cites two reasons why an individual incurs backup withholding: incorrect information and underreporting.
Incorrect information
Backup withholding is often due to an incorrect name or tax identification number on your W-9 form. However, this type of error can usually be easily fixed by providing your payer with the corrected Form W-9 information as soon as you’ve been made aware of the mistake.
Pro Tip
Take a few seconds to double-check your tax documents before submitting them to your payer. This can decrease the chances of you being subject to backup withholding and the hassle that may come along with it.
Underreported interest or dividends
As mentioned previously, the IRS will send four notices over a period of 120 days to notify you of underreported interest or dividends.
Don’t panic if you’ve received some of these letters in the mail. There is the option of asking the IRS to stop the backup withholding or prevent it from happening if you can prove that:
- You do not have any underreported interest or dividends.
- You have a bona fide dispute with the IRS about whether you actually underreported your interest and dividends income.
- Backup withholding will cause undue hardship for you and it is unlikely for you to underreport interest and dividends in the future.
- You have filed an original return reporting the interest and dividend income if you haven’t already done so. Or, you’ve filed an amended return and paid the taxes, penalties, and interest due for underreported income.
Pro Tip
Make sure to always provide accurate information when it comes to reporting to the IRS. If you attempt to avoid backup withholding by providing false information, you might face civil and legal consequences. The civil penalty is usually a fine of $500. The criminal penalty could leave you with fines and/or imprisonment.
FAQs
How do I get my backup withholding back?
Similar to other types of withholding tax, the amount of backup payment withheld from you can be refunded. When you have income tax withheld under the back withholding rule, it will be shown on your Form 1099 or W-2G. Make sure to report the federal income tax withholding amount on your return for the year that you received the income.
If you did overpay, you’ll receive a refund from the government.
How do I stop or prevent backup withholding?
To stop backup withholding from occurring, you need to figure out why you’ve become subject to it in the first place.
If you’ve been notified by a payer that the TIN you provided was incorrect, you can usually prevent or stop backup withholding by simply providing the payer with your correct information. If the withholding is due to underreported interest or dividend income, you can resolve it by paying the amount owed or filing missing returns.
What is an IRS B notice?
The IRS B notice is essentially a notice that the IRS sends to the payer if it fails to match the TIN information and the name that you provided on your W-9. After receiving the notice, the payer should send a copy of the B notice to you and request that you provide the correct and updated information. If you ignore the request, you may then be subject to backup withholding.
If the payer fails to respond to the IRS B notice, they could also incur incorrect filing penalties and interest, and even run into trouble during IRS audits.
Key Takeaways
- Backup withholding is a type of federal income tax levied against investment income when you fail to provide the payer a correct taxpayer identification number, or have failed to report your income from interest or dividends in the past.
- Some examples of income types subject to backup withholding include interest, dividends, payments from brokers on securities transactions, commissions and fees paid to independent contractors, etc.
- If you provided your payer with an incorrect name or tax identification number on your W-9 Form, make sure to send your payer the updated and correct information as soon as you’re aware of the mistake.
- If you’ve been notified by the IRS of your underreported interest and dividends income, make sure to take necessary steps to prevent or stop backup withholding from occurring. This may require you to file an amended tax return and pay any taxes or penalty fees you owe.
- Attempting to avoid backup withholding by providing false information could result in civil and legal consequences. This could include hefty fines and even imprisonment.
Stop backup withholding before it starts
Whether it’s due to a typo in your tax documents or underreported interest and dividends earnings, make sure to resolve these issues as soon as possible to avoid backup withholding and trouble with the IRS.
If you are having difficulties paying the taxes you owe, you should contact the IRS as soon as you can. You can also get a free consultation with a tax relief professional and discuss your options. They may be able to assist you with working out a payment plan or other solutions to help you pay off your tax debt.
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