Backup withholding is a federal tax withholding mechanism used by the IRS to ensure it collects taxes on certain types of income payments, especially when the taxpayer has not provided correct taxpayer information or has underreported income. It requires payers (such as banks, brokers, or businesses) to withhold 24% of specific payments and send it directly to the IRS instead of paying the full amount to the taxpayer
When Backup Withholding Applies
Backup withholding may be required in these situations:
- The taxpayer fails to provide a correct Taxpayer Identification Number (TIN), such as a Social Security Number (SSN), Employer Identification Number (EIN), or Individual Taxpayer Identification Number (ITIN), to the payer
- The taxpayer has underreported interest or dividend income on their federal tax return or fails to certify they are not subject to backup withholding
- The IRS issues a backup withholding order against the taxpayer
Payments Subject to Backup Withholding
Backup withholding can apply to many types of payments reported on IRS Forms 1099 and W-2G, including:
- Interest payments
- Dividends
- Rents and royalties
- Commissions and fees for independent contractors
- Patronage dividends
- Gambling winnings not subject to regular withholding
- Payments from brokers and barter exchanges
Purpose and Impact
The purpose of backup withholding is to ensure the IRS receives tax revenue from income that might otherwise go unreported or unpaid. The withheld amount counts as a credit toward the taxpayer’s annual income tax liability, and any excess withheld can be refunded after filing a tax return
Summary
Backup withholding is a 24% tax withheld on certain payments when a taxpayer fails to provide correct tax information or has reporting issues. It helps the IRS secure tax payments on income like interest, dividends, and other non- payroll payments
