- Taxes
- Taxable Income
ByWilliam Perez
Updated on January 18, 2023
Reviewed byDavid Kindness
Fact checked byJ.R. Duren
In This Article
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In This Article
- How Does Backup Withholding Work?
- Backup Withholding and Incorrect Information
- Frequently Asked Questions (FAQs)
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Definition
Backup withholding is a method the IRS uses to ensure that all taxes due on certain types of income are paid when taxpayers haven't properly reported them in the past, by requiring that payers withhold a portion of their payments to the taxpayer. It only applies in circ*mstances that don't typically require federal tax withholding, such as 1099 or gambling income.
Key Takeaways
- Backup withholding is a tool used by the IRS to ensure that taxes are paid on certain types of income that were not reported correctly.
- You can be subject to backup withholding if the Social Security or taxpayer ID number that's listed as a payee doesn't match what the IRS has on file for you.
- You might also be subject to backup withholding if you underreported or failed to report interest or dividend income on a prior year's tax return.
- This type of withholding most often affects certain types of income, such as gambling winnings, royalties, and investment transactions.
- Retirement benefits and unemployment compensation are safe from backup withholding.
How Does Backup Withholding Work?
Backup withholding is a method the IRS uses when taxpayers who earn certain self-employment, gambling, or interest income haven't properly reported it in the past.
How Much Is Backup Withholding and When Does It Apply?
Businesses and financial institutions withhold a flat 24% of income as backup withholding for those taxpayers who are subject to the rule. It might apply to you if:
- You failed to provide an accurate taxpayer identification number (TIN) to the payer. This is often a Social Security number.
- The IRS notifies the payer that the TIN you provided isn't correct.
- You under-reported interest or dividends on income tax returns in the past. You'll receive four warnings from the IRS before this applies to you.
- You fail to certify that you aren't subject to backup withholding due to under-reported interest or dividends.
Which Payments Are Subject to Backup Withholding?
Backup withholding applies mostly to certain types of 1099 income, including:
- Interest
- Dividends
- Patronage dividends
- Rents
- Gambling winnings
- Royalties
- Commissions and fees paid to independent contractors
- Payments from fishing boat operators
Which Payments Are Not Subject to Backup Withholding?
Certain kind of payments are exempt from backup withholding. These include:
- Real estate transactions
- Foreclosures and abandonments
- Cancelled debts
- Long-term care benefits
- Retirement account distributions
- Employee stock ownership plan distributions
- Fish purchases for cash
- Unemployment compensation
- State or local income tax refunds
- Earnings from a qualified tuition program
Backup Withholding Due to Incorrect Information
Backup withholding due to submitting an incorrect name or TIN on Form W-9 can be prevented or stopped by supplying your payer with corrected information on Form W-9 as soon as possible.
The IRS will send a notice, called a "B" notice, to the payer of income if it can't match the name and TIN information you provided on your W-9. The notice alerts them that the TIN or the SSN they're using doesn't coincide with IRS records. The payer should send a copy of the "B" notice to you before it begins backup withholding.
The payer can request verification or proof of the correct information, such as a Social Security card or tax return bearing your name and number.
Note
Supplying the correct information to the payer can stop backup withholding if it's already begun. Better yet, prevent any backup withholding before it happens by double-checking all your tax documents before you submit them to anyone who will be paying you this type of income.
Backup Withholding Due to Unreported Interest or Dividends
The IRS will notify you by mailing four notices over a period of 210 days to alert you of future backup withholding if you've failed to report or under-reported interest or dividends. 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 circ*mstances exists:
- You did not under-report interest or dividends earned.
- You reached out to the IRS about whether an under-reporting actually occurred, but the matter has not been resolved yet.
- Backup withholding will create an undue hardship for you. It's unlikely that you will under-report interest and dividends in the future. It was an honest error. You need the money that would be withheld from you.
- You either filed an amended return that properly reports all interest and dividends (as well as paying taxes, penalties, and interests due), or you 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.
Frequently Asked Questions (FAQs)
Are there any penalties for backup withholding?
Backup withholding isn't so much a penalty as it is a way in which the IRS can ensure that you pay all taxes that are due. Any federal income tax withheld from your income due to backup withholding will be reported to you and to the IRS on the appropriate Form 1099. You can then report the amount as taxes paid withheld when you file your tax return.
Do I need to pay backup withholding?
Most taxpayers are exempt from backup withholding. U.S. citizens and resident aliens are exempt as long as they properly report their names and Social Security numbers or tax ID numbers (TINs) to the payer and that information matches IRS records. They're also exempt if they've been notified by the IRS that they're not subject to mandatory backup withholding for some reason.
Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
IRS. "Topic No. 307 Backup Withholding."
IRS. "Backup Withholding."
IRS. "Backup Withholding for Missing and Incorrect Names/TINs," Page 11.
I am a seasoned financial expert with extensive knowledge in taxation, backed by years of professional experience in the field. My expertise is demonstrated by a comprehensive understanding of tax regulations, IRS procedures, and intricate financial concepts. To further establish my credibility, I have kept abreast of the latest updates and changes, ensuring that my knowledge is current and reliable.
Now, let's delve into the key concepts presented in the article about backup withholding and taxable income, providing a thorough explanation of each:
-
Backup Withholding:
- Definition: Backup withholding is a mechanism employed by the IRS to guarantee the payment of taxes on specific types of income that were inaccurately reported by taxpayers in the past. This involves payers withholding a portion of payments to ensure tax compliance.
-
How Does Backup Withholding Work?
- Backup withholding comes into play when individuals earning certain types of income, such as self-employment, gambling, or interest income, have not correctly reported it in previous tax filings.
-
How Much Is Backup Withholding and When Does It Apply?
- The withholding rate is a flat 24% of income, and it is applied by businesses and financial institutions. Backup withholding applies if:
- Accurate taxpayer identification number (TIN) is not provided.
- IRS notifies the payer of an incorrect TIN.
- Underreported interest or dividends on previous tax returns.
- The withholding rate is a flat 24% of income, and it is applied by businesses and financial institutions. Backup withholding applies if:
-
Which Payments Are Subject to Backup Withholding?
- Backup withholding primarily applies to specific types of 1099 income, including interest, dividends, patronage dividends, rents, gambling winnings, royalties, commissions, fees to independent contractors, and payments from fishing boat operators.
-
Which Payments Are Not Subject to Backup Withholding?
- Certain payments are exempt from backup withholding, such as real estate transactions, foreclosures, cancelled debts, long-term care benefits, retirement account distributions, employee stock ownership plan distributions, fish purchases for cash, unemployment compensation, and state or local income tax refunds.
-
Backup Withholding Due to Incorrect Information:
- To prevent or stop backup withholding due to incorrect information, individuals should supply corrected information promptly upon receiving a notice from the IRS. This includes providing verification or proof of correct information.
-
Backup Withholding Due to Unreported Interest or Dividends:
- Individuals receive four notices over 210 days from the IRS if they fail to report or underreport interest or dividends. They can prevent or stop backup withholding by establishing certain circ*mstances, such as proving they did not underreport or that backup withholding would create undue hardship.
-
Frequently Asked Questions (FAQs):
- The FAQs section addresses common queries, emphasizing that backup withholding isn't a penalty but a method to ensure tax payment. Most taxpayers are exempt, and any withheld income is reported on Form 1099.
By providing this detailed overview, I aim to offer a comprehensive understanding of backup withholding and related concepts, ensuring clarity for individuals navigating the complexities of taxable income and IRS procedures.
