CARL WATTS & ASSOCIATES

June 24, 2019

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Backup Withholding
You are perhaps familiar with the term “backup” as the computing function of making copies of data to enable recovery from data loss, and with the term “withholding” in reference to an employer deducting tax from an employee's paycheck. Associated, these two are right up our alley!

In short, backup withholding (BWH) is the method used by the IRS to make sure that the government is able to collect taxes on all appropriate income, particularly income that isn't usually subject to withholding like interest or stock profits.


Rest assured, most taxpayers are not subject to backup withholding. This kind of withholding is usually triggered when a taxpayer fails to supply the correct taxpayer identification number (TIN) to a payer, or following notification by the IRS, when a taxpayer has underreported interest or dividend income on their federal income tax return.

Please note that taxpayers who make payments are known as “payers,” while those who receive payments are known as “payees.”

The person or business paying a taxpayer doesn’t generally withhold taxes from certain payments. They don’t do this because it’s assumed the taxpayer will report and pay taxes on this income when they file their federal tax return. There are, however, situations when the payer is required to withhold a certain percentage of tax to make sure the IRS receives the tax due on this income.

Under a key change made by the Tax Cuts and Jobs Act enacted in December 2017, the backup withholding tax rate dropped from 28 percent to 24 percent, effective Jan. 1, 2018 to 2025 to be paid to the IRS on most kinds of transactions reported on variants of Form 1099.

This 24 percent tax is taken from any future payments to ensure the IRS receives the tax due on this income and may be required:


  • Under the BWH-B program because you failed to provide a correct taxpayer identification number to the payer for reporting on the required information return. A TIN can be either your social security number (SSN), employer identification number (EIN), or individual taxpayer identification number (ITIN), or adoption taxpayer identification number;

  • Under the BWH-C program because you failed to report or underreported interest and dividend income you received on your federal income tax return; or you failed to certify that you're not subject to BWH for underreporting of interest and dividends.


Backup withholding can apply to most kinds of payments reported on Forms 1099 and W-2G, including:

  • Interest payments (Form 1099-INT)

  • Dividends (Form 1099-DIV)

  • Payment Card and Third Party Network Transactions (Form 1099-K)

  • Patronage dividends, but only if at least half the payment is in money (Form 1099-PATR)

  • Rents, profits, or other gains (Form 1099-MISC)

  • Commissions, fees, or other payments for work you do as an independent contractor (Form 1099-MISC)

  • Payments by brokers/barter exchanges (Form 1099-B)

  • Payments by fishing boat operators, but only the part that is in money and that represents a share of the proceeds of the catch (Form 1099-MISC)

  • Royalty payments (Form 1099-MISC)

  • Gambling winnings (Form W-2G) may also be subject to backup withholding

  • Original issue discount reportable on (Form 1099-OID), Original Issue Discount, if the payment is in cash

  • Certain Government Payments, Form 1099-G

When you open a new account, make an investment, or begin to receive payments reportable on a Form 1099, you must furnish your taxpayer identification number to the bank or other business. In some cases you must furnish your TIN in writing and certify under penalties of perjury that it is correct.

The bank or business will give you Form W-9, Request for Taxpayer Identification Number and Certification, or a similar form. You must enter your TIN on the form and, if your account or investment will earn interest or dividends, you also must certify that you are not subject to backup withholding due to previous underreporting of interest and dividends.
As a payer, you must request a W-9 from any person or entity that you expect to report compensation on Form 1099. Form W-9 lists the name, identifying number and mailing address of the party you compensate. In addition, the payee lists the type of entity he is.

The payee must provide this information to you and sign the form, certifying that he is not subject to backup withholding. You must retain the form with your records, but do not send the form to the IRS unless it is requested.

If you are the payer (for example if you filed a 1099-MISC for a contractor) and the IRS sends you a CP2100 or CP2100A Notice indicating an incorrect payee TIN, you are required to send the “B” Notice (which is a backup withholding notice) within 15 days from the date you received it, or the date of the CP2100/2100A, whichever is later.

If you have to withhold backup payments from a payee, you must report the withholding on Form 945, Annual Return of Withheld Federal Income Tax. Only use this form to report amounts withheld from payments reported on a Form 1099. Do not use the form to report payroll withholding for W-2 wage employees.

In addition, you must deposit backup withholding amounts on the 15th of each month following the month of the withholding. Use Form 945 to reconcile the deposits you make during the year. If you make all deposits on time, you should not owe additional tax on Form 945.

The usual problem with backup withholding is that, by the time you issue a 1099 to the IRS on behalf of the party, you have also already issued the compensation.

You can avoid this issue by using the IRS TIN Matching system. This system allows you to enter a TIN electronically to see if the payee is subject to withholding. To use this product, you must register for e-Services through the IRS website. The e-Services portal is generally used by tax professionals, but any company who issues 1099 compensation may use the system to verify taxpayer identification numbers.


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. If successful, the IRS should provide you with a certification showing you have corrected the situation and notify the particular financial institutions.

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.

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.

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 can then claim the amount withheld on your tax return.

Some payments are excluded from backup withholding:

  • Real estate transactions;
  • Foreclosures and abandonments;
  • Cancelled debts;
  • Distributions from Archer MSAs;
  • Long term care benefits;
  • Distributions from any retirement account;
  • Distributions from an employee stock ownership plan;
  • Fish purchases for cash;
  • Unemployment compensation;
  • State or local income tax refunds;
  • Qualified tuition program earnings.

Generally, backup withholding applies only to U.S. citizens, resident aliens and not to nonresident aliens. The payer who neglects or refuses to do backup withholding when required will himself be held liable for the amount of the backup withholding which should have been withheld from any payments.


More information on backup withholding may be found in: Publication 1281, Backup Withholding on Missing and Incorrect Name/TINs, and General Instructions for Forms 1099, 1098, 5498, and W-2G.

Reporting income and payments from different 1099 forms may not seem complicated, nevertheless, help from a tax professional is advisable in all your dealings with the IRS to prevent possible omissions or mistakes that may cause problems for years to come.
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