Posted by The TaxAdvocate Group, LLC

Understanding Backup Withholding

Understanding Backup Withholding

We define backup withholding as a form of federal tax withholding on income that wouldn't usually require tax withholding. While some forms of income are not subjected to taxes, there are cases in which taxpayers might need to hold a particular portion of their payment. 

Majorly, backup withholding has to do with some forms of gambling income or 1099 in exceptional cases. This article explains how to know if your income will have backup withholding and what is expected of you. 


What is Backup withholding?

Backup withholding is an approach from Uncle Sam when some taxpayers who earn some gambling, self-employment, or interest income do not correctly report their tax. According to this rule, financial firms and businesses must withhold 24% of their income as the backup withholding. 

Here are cases in which it might apply to you

  • You didn't supply a correct taxpayer identification number to the payer.

  • The IRS sends a notice to the payer that the TIN supplied is wrong.

  • In the past, you had dividends or underreported interests on your income tax.

  • You did not certify that backup withholding does apply to you because of the interests and dividends you did not report. 

Generally, backup withholding applies to a type of 1099 income like:

  • Rents

  • Interest

  • Patronage dividends

  • Royalties

  • Gambling winnings

  • Fees and commissions you paid to independent contractors.

  • Payments coming from fishing boat operators

All payments in which compulsory withholding does not apply are real estate deals, forgiven debts, unemployment compensation, and retirement account distribution. 

Before the Tax Cuts and Job Acts, the backup withholding rate was 28%. At the beginning of 2018, the rate was brought down to 24%.


How backup withholding Works

The process of backup withholding varies due to the reason behind the withholding. 


Withholding as a Result of Wrong Information

If you submit a wrong name or TIN on Form W9 and it triggers a backup withholding, giving your payer with the right information as soon as you can, can stop the backup withholding. 

If your detail does not match the name and TIN info available on your W-9, Uncle Sam will send a 'B' notice to the payer informing them of the discrepancy in the TIN or SSN. You will have a copy of the 'B' notice before the backup withholding process commences.

The payer cannot just call you and request the right information on mobile. There could be a request for the verification of the correct information, like a social security card.

Even if the backup withholding already started, making the correct information available can halt the process. Although, you are better off preventing this by making sure your details are correct. 


Withholding because of Dividends or Unreported Interest

For people with unreported dividends or interests, you will be notified by the IRS. Through the period of 210 days, the IRS will send you four notices to inform you of a possible backup in the future. There is the opportunity to stop the process by confirming that one of the following circumstances is valid:

  • Your interest and dividends were correctly reported.

  • You are already consulting with Uncle Sam about the underreporting, although it is yet to be resolved.

  • The backup withholding process made your life miserable, but the chances of you repeating the act in the future are pretty slim.

  • You have already submitted an amended return which reports all dividends and interest. You also might have filed an original return to report the income since you didn't file one before. 

There will be a certification from the IRS, which will notify any payer that already had notice sent to them if it determines that the backup withholding should stop. 


Who is exempt from backup withholding?

As long as U.S. citizens can properly report their name, social security number, or TIN to their payer with Form W9, they are exempt from backup withholding. The information must corroborate Uncle Sam's record. 

Also, in some cases, the IRS might notify taxpayers that they do not have to worry about backup withholding for some reason.


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