Backup withholding is a type of federal tax withholding on income that otherwise typically doesn't require tax withholding. Although some types of income usually don't have taxes withheld, some situations may require that payers withhold a portion of their payments to you.
Backup withholding only appliesto certain types of 1099 or gambling income in specific circumstances. Learn whether your income may be subject to backup withholding, and what to expect if this applies to you.
Most taxpayers are exempt from backup withholding.
What Is Backup Withholding?
Backup withholding is a method the IRS uses when taxpayers who earn certain self-employment, gambling, or interest income haven't properly reported it in the past. Businesses and financial institutions withhold a flat 24% of income as backup withholding in these cases. This may apply to you if:
- You have failed to provide an accurate taxpayer identification number (TIN) to the payer. This is often a Social Security number.
- The Internal Revenue Service (IRS) notifies you that the TIN you provided isn't correct.
- You have under-reported interest or dividends on income tax returns in the past. You will get four warnings from the IRS before this applies to you.
- You fail to certify that you are not subject to backup withholding due to under-reported interest or dividends.
Backup withholding generally only applies to certain types of 1099 income, including:
- Patronage dividends
- Gambling winnings
- Commissions and fees paid to independent contractors
- Payments from brokers on stock and bond transactions
- Payments from fishing boat operators
Payments that are not subject to mandatory withholding include canceled debts, real estate transactions, retirement account distributions, and unemployment compensation.
The backup withholding rate was 28% before the Tax Cuts and Jobs Act went into effect in 2018. It dropped by 4% effective January 1, 2018.
How Does Backup Withholding Work?
The process for initiating backup withholding will play out according to why the IRS is requiring it be withheld.
Withholding Due to Incorrect Information
Backup withholding due to submitting an incorrect name or TIN on Form W-9 can be prevented or stopped by supplying your payer with corrected information on Form W-9 as soon as possible.
If it cannot match the name and TIN information you provided on your W-9, the IRS will send a notice—called a "B" notice—to the payer of income, alerting them that the TIN or the SSN they're using doesn't coincide with IRS records. The payer should send a copy of the "B" notice to you before it begins backup withholding.
The payer is prohibited from simply calling you and requesting the correct information by phone. They might also request verification of the correct information, such as a Social Security card.
Supplying the correct information to the payer can stop backup withholding if it's already begun. Better yet, prevent any backup withholding before it happens by double-checking all tax documents before you submit them.
Withholding Due to Unreported Interest or Dividends
In the case of unreported (or under-reported) interest or dividends, the IRS will notify you by mailing four notices over a period of 210 days to alert you of future backup withholding. You can ask the IRS not to resort to backup withholding or to stop it after it's begun, but you must establish that one of four acceptable circumstances exists:
- You did not under-report interest or dividends earned.
- You've reached out to the IRS about whether an under-reporting actually occurred, but the matter has not been resolved yet.
- Backup withholding will create an undue hardship for you, and it's unlikely that you will under-report interest and dividends in the future. (In other words, it was an honest error, and you need the money being withheld from you.)
- You've either filed an amended return that properly reports all interest and dividends (as well as paying taxes, penalties, and interests due) or filed an original return reporting the income (if you didn't previously file one).
The IRS will provide you with certification and will notify any payers who were sent notices if it determines that backup withholding isn't required or that it should stop.
Can I Recover Backup Withholding?
Backup withholding is a precaution, as the name suggests. It's not so much a penalty as a way in which the IRS can ensure that you ultimately pay all taxes that are due.
Any federal income tax withheld from your income due to backup withholding will be reported to you and the IRS on the appropriate Form 1099, such as 1099-INT for interest income, or Form W-2G for gambling winnings. You can then report the amount as taxes withheld when you file your tax return. You'll receive a refund at tax time if you had more taxes withheld than what you actually owe.
Partnerships and S corporations cannot claim a refund for overpaid backup withholding. The refund must be claimed by the partners or shareholders.
Who Is Exempt from Backup Withholding?
U.S. citizens and resident aliens are exempt from backup withholding if they properly report their names and Social Security numbers or TINs to the payer using Form W-9, and if that information matches IRS records.
They're also exempt if they've been explicitly notified by the IRS that they're not subject to mandatory backup withholding for some reason.
- The IRS can require income an payers to take backup withholding from certain types of self-employment, interest, rental, and gambling income if the taxpayer fails to provide correct information.
- If you provide all payers with the correct name and taxpayer identification number (TIN) and report all interest and dividend income accurately, you should not have to have backup withholding taken from your income.
- As with other tax withholding, you can receive a refund for any amounts you have overpaid.
- Most taxpayers are not subject to backup withholding.