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Backup Withholding

Backup Withholding

Many businesses will request an IRS Form W-9 to issue an IRS Form 1099. A Form W-9 verifies the taxpayer's identification number, usually the Social Security number, or if you're a business, your employee identification number. If you want to get paid, refusing to hand over a W-9 may not make sense. The IRS says that whenever a payor believes they should report a payment on an IRS Form 1099, they should request a W-9 Form. If you fail to submit one, they may be required to withhold tax on the payment, even if you are not an employee. This 24% "backup withholding" is the usual consequence of refusing to submit a W-9 form. The 1099 forms allow for computerized matching of Social Security numbers to amounts paid and received, simplifying IRS collection efforts. Failure to follow a Form 1099 on your tax return triggers an IRS notice asking you to explain or pay. 

Let's use an illustration to explain this. Suppose a lawyer solves a $2 million case with payment to the lawyer's trust account. Suppose 70% is for the client and 30% for the lawyer. The lawyer will likely receive a Form 1099 showing a total gross income of $2 million. The lawyer can report the $ 600,000 he/she got as income without worrying about comparing the computer because gross proceeds are not considered income. The client is usually not that lucky. Unless the settlement is a non-income settlement (for example, compensatory damage for personal injury) or a capital recovery, the client may receive a 1099-MISC form (probably in box 3) for a total of $2 million. 

Next, the client must know how to deduct the $600,000 for attorney fees, if allowed. As of 2018, it is more difficult to find a way to claim legal tax deductions in many types of cases. Therefore, Form 1099 is even more important. Can you avoid filing taxes by being cagey about your social security number or tax ID number? Perhaps, but it can sometimes be pretty tough to do if you want to get paid. Form 1099 requires taxpayer-identification numbers, which is why attorneys are generally required to provide payers with their law firm and clients' identification numbers.

Typically, the request is to sign and return a W-9 form. Should lawyers and clients agree? Usually, if they don't agree, the money won't get paid, or the payer may decide to withhold 24% "backup withholding" and send it to the IRS. However, the W-9 Form may make you uncomfortable. A plaintiff in a personal injury case who has just obtained the defendant's consent not to issue a Form 1099 may want to know why he/she is asked to file a Form W-9. After all, Form W-9 is intended to provide and verify the taxpayer's social security number. Does not having the Form necessarily mean that the defendant will issue a 1099 form? Not really; it can only mean that the defendant will not pay much to anyone without a signed form. In addition to providing the beneficiary's Social Security number, Form W-9 certifies that the beneficiary is a U.S. person (that is, a U.S. citizen or tax resident) and therefore is not subject to burdensome reporting and Withholding obligations, often required for "outbound" payments to non-Americans.

Therefore, many companies have a policy of requesting signed W-9 forms for any payment. It doesn't seem to happen often, but there is a possible penalty for refusing to provide a signed W-9 Form when asked to do so. If a payee is asked to provide a taxpayer identification number and fails to provide it to the payer, the taxpayer will be fined $50 to provide that information. A more effective remedy is probably the threat of an additional 24% backup withholding. A recipient who provides false or inaccurate information or refuses to submit a Form W-9 upon request is subject to backup withholding.

Therefore, when a payer requests a W-9 form, it is usually not worth fighting about providing it, especially if 1099 forms are already known to be issued. Disputes over 1099 forms are common. Form 1099 regulations are complex, and many businesses make mistakes when issuing them. Recipients may not like it, and sometimes legal steps are taken to issue 1099 forms. Most cases don't seem to go too far, perhaps precisely, because it is often possible to justify what is issued. Therefore, although you may need to provide an IRS Form W-9 to receive a payment if such a form is required, try to avoid Form 1099 issues whenever you can. 


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