• Banking and Finance

  Backup Withholding Requirements from the IRS

  Posted by Kevin Young on October 25, 2022 at 3:54 am

  In American tax administration, backup withholding is a specified percentage (24% for tax years 2018-2025 but previously 28%) withheld by the payers to be paid to the IRS on most kinds of transactions reported on variants of Form 1099. Backup withholding is a tax that is levied on investment income, at an established tax rate, as the investor withdraws it. For payments not subject to withholding, payers are required to withhold the tax. Backup withholding helps to ensure that government tax-collecting agencies, such as the Internal Revenue Service (IRS) or Canada Revenue Agency, will be able to receive income taxes owed to them from investors’ earnings.

  Backup withholding may be required for several reasons, including but not limited to:

  • an improper TIN/ITIN/ATIN on the W-9

  • an IRS backup withholding order

  • certain types of payment are always subject

  Banks or other businesses that pay certain kinds of income must file an information return (Form 1099) with the IRS. Backup withholding may be applied when an investor has not met rules regarding taxpayer identification numbers (TIN). At the time the investor withdraws his or her investment income, the amount mandated by the backup withholding tax is remitted to the government, immediately providing the tax-collecting body with the required funds but leaving the investor with less short-term cash flow. The Form 1099 shows how much an individual was paid during the year. It also includes the individual’s name and Social Security Number (SSN) or other taxpayer identification number (TIN).

  How Backup Withholding Works?

  Investors commonly earn income—for example, interest payments, dividends, capital gains—from assets in which they have invested. While this income is taxable at the time it is received, the taxes owed on a calendar year’s investment income only come due once every year, during tax season.

  Thus, investors could potentially spend all of their investment income before the annual income taxes come due. This could render them unable to pay taxes, leaving the IRS with the difficult and expensive job of collecting the taxes owed. It is primarily this risk that motivates the government to sometimes require backup withholding taxes to be levied by financial institutions at the time investment income is earned.

  Payments subject to backup withholding

  BWH can apply to most kinds of payments reported on Forms 1099 and W-2G, including:

  • Interest payments (Form 1099-INT)

  • Dividends (Form 1099-DIV)

  • Payment Card and Third Party Network Transactions (Form 1099-K)

  • Patronage dividends, but only if at least half the payment is in money (Form 1099-PATR)

  • Rents, profits, or other gains (Form 1099-MISC)

  • Commissions, fees, or other payments for work you do as an independent contractor (Form 1099-MISC)

  • Payments by brokers/barter exchanges (Form 1099-B)

  • Payments by fishing boat operators, but only the part that is in money and that represents a share of the proceeds of the catch (Form 1099-MISC)

  • Royalty payments (Form 1099-MISC)

  • Gambling winnings (Form W-2G) may also be subject to backup withholding.

  • Original issue discount reportable on (Form 1099-OID), Original Issue Discount, if the payment is in cash

  • Certain Government Payments, Form 1099-G

  How to prevent or stop backup withholding

  To stop backup withholding, you’ll need to correct the reason you became subject to backup withholding. This can include providing the correct TIN to the payer, resolving the underreported income and paying the amount owed, or filing the missing return(s), as appropriate.

  Payments excluded from backup withholding

  Payments that are excluded from backup withholding:

  • Real estate transactions

  • Foreclosures and abandonments

  • Cancelled debts

  • Distributions from Archer MSAs

  • Long term care benefits

  • Distributions from any retirement account

  • Distributions from an employee stock ownership plan

  • Fish purchases for cash

  • Unemployment compensation

  • State or local income tax refunds

  • Qualified tuition program earnings

  Credit for backup withholding

  If your 1099 shows an amount withheld under the backup withholding rules, report the amount as federal income tax withheld on your income tax return for the year you received the income.

  If you operate as a partnership or subchapter S corporation, any backup withholding can only be claimed by the partners and shareholders. Partners and shareholders should report their respective shares of the withheld amounts on their individual income tax returns. The amounts aren’t refundable to the partnership or subchapter S corporation.

  Filing Form 945

  First, you must file Form 945 with the IRS. Form 945 is an annual report form, used for reporting all backup withholding for all payees for the year. You can e-file this form or send it by mail. If you send by mail, where you send the form depends on whether you are making a payment.

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