Types of Income Subject to Backup Withholding
IRS Requirements and Exemptions
Backup withholding is a type of tax withholding on specific types of income for federal tax purposes. Backup withholding may be mandatory in certain circumstances. Most taxpayers, however, are exempt from backup withholding. Federal income tax may be withheld at a flat rate of 28% on the following types of income:
Who's Exempt from Backup Withholding
U.S. citizens and resident aliens will be exempt from backup withholding if:
- You properly report your name and Social Security number to the payer using Form W-9, and that information matches the IRS records, and
- You have not been notified by the IRS that you are subject to mandatory backup withholding.
When the IRS Requires Backup Withholding
The IRS requires businesses and financial institutions to withhold 28% of the types of income mentioned above as backup withholding when:
- "You do not give the payer your TIN [taxpayer identification number] in the required manner.
- "The IRS notifies the payer that the TIN you gave is incorrect.
- "The IRS notifies the payer to start withholding on interest or dividends because you have underreported interest or dividends on your income tax return. The IRS will do this only after it has mailed you four notices over at least a 120-day period.
- "You fail to certify that you are not subject to backup withholding for underreporting of interest and dividends." (from Tax Topic 307, Backup Withholding)
How to Prevent Backup Withholding
Backup withholding due to incorrect name or TIN on Form W-9: Backup withholding can be prevented by supplying the payer of income with your correct taxpayer identification number (TIN) and name on Form W-9 and certifying that you are not subject to backup withholding.
If the name and TIN provided on Form W-9 do not match the IRS's records, the IRS may send a notice (called a "B" notice) to the payer of income alerting them that the TIN does not match the IRS's records. The payer of income will send a copy of the "B" notice to the recipient of income. "If you receive a 'B' notice from a payer, notifying you that the TIN you gave is incorrect, you usually can prevent backup withholding from starting or stop backup withholding once it has begun by giving the payer your correct name and TIN.
You must certify that the TIN you give is correct."
Sometimes, however, the name and TIN will still not match the IRS's records, in which case the IRS will send a second "B" notice to the payer of income, and the payer of income will send a copy of this "B" notice to the recipient of income. "If you receive a second 'B' notice from that payer, you will need to provide the payer with verification of your TIN from the Social Security Administration or the IRS." (from Tax Topic 307, Backup Withholding)
Backup withholding due to previous underreported interest or dividends: The IRS sometimes will require backup withholding on interest income and dividends if a taxpayer previously underreported the amount of interest income or dividend income on their tax return.
In such cases, the IRS will notify the taxpayer by mailing "four notices over at least a 120-day period" to alert the taxpayer of future backup withholding (from Tax Topic 307, Backup Withholding). The procedure for correcting this situation is outlined by the IRS in Publication 505, Tax Withholding and Estimated Tax, as follows:
"If you have been notified that you underreported interest or dividends, you must request and receive a determination from the IRS to prevent backup withholding from starting or to stop backup withholding once it has begun. Your request must show that at least one of the following situations applies.
- "No underreporting occurred.
- "You have a bona fide dispute with the IRS about whether an underreporting occurred.
- "Backup withholding will cause or is causing an undue hardship, and it is unlikely that you will underreport interest and dividends in the future.
- "You have corrected the underreporting by filing an original return if you did not previously file one, or by filing an amended return, and by paying all taxes, penalties, and interest due for any underreported interest or dividend payments.
"If the IRS determines that backup withholding should stop, it will provide you with certification and will notify the payers who were sent notices earlier." (from Publication 505, Tax Withholding and Estimated Tax)
How to Recover the Amount of Backup Withholding
Any federal income tax withheld from your income due to backup withholding will be reported to you and to the IRS using the appropriate Form 1099 (such as 1099-INT for interest income). You would then report the amount of withholding when you file your tax return.