What is Backup Withholding? by Cherry Laufenberg, CPA
Under the U.S.’s pay-as-you-go system of taxation, individuals are responsible for reporting and paying taxes on all income they receive in a given tax year, either as it is received or by the date of the taxpayers’ annual tax return-filing deadline. While taxes are automatically withheld from most workers’ wages and paid directly to the IRS, the same is not true for other sources of income individuals may receive throughout the year. When individuals fail to accurately report and/or pay tax on all their income sources, or when their taxpayer identification numbers (TINs) do match those on file with the IRS, they may be subject to backup withholding on these income payments in the future.
In enforcing the country’s tax laws, the IRS generally compares the information taxpayers report on their individual tax returns against the information it receives from banks, businesses or other parties that make payments directly to those taxpayers. If the IRS detects a discrepancy between the amount reported by the taxpayer and the amount reporter by the payer, it may require the payer to withhold a percentage of future payments it makes to taxpayers and submit that amount directly to the IRS to ensure the agency receives the taxes that are due.
The current backup withholding rate is a flat 24 percent on the following forms of payments taxpayers receive but underreport or fail to report on their individual income tax returns:
- Interest payments (Form 1099-INT)
- Dividends (Form 1099-DIV) Rents, profits or other income or gains (Form 1099-MISC)
- Commissions, fees, or other payments for work performed as an independent contractor (Form 1099-MISC)
- Payments by brokers and barter exchange transactions (Form 1099-B)
- Royalty payments (Form 1099-MISC)
- Gambling winnings (Form W-2G)
- Patronage dividends when at least half of the payment is in money (Form 1099-PATR)
- Payments by fishing boat operators (only the part that is in money and that represents a share of the proceeds of the catch (Form 1099-MISC)
- Original issue discount reportable on (Form 1099-OID), Original Issue Discount, if the payment is in cash
- Certain Government Payments (Form 1099-G)
By contrast, backup withholding generally will not apply to payments involving real estate transactions, foreclosures and abandonments, cancelled debts, long-term care benefits, distributions from retirement accounts, unemployment compensation, distributions from an employee stock ownership plan (ESOP), state or local income tax refunds and qualified tuition program earnings.
To prevent or stop backup withholding, taxpayers will need to correct the reasons they became subject to backup withholding in the first place. Generally, taxpayers can avoid backup holding by providing payers with their correct TINs, paying amounts past due and/or filing missing tax return(s) immediately after receiving notice from the IRS.
About the Author: Cherry Laufenberg, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where she provides tax and accounting planning and compliance services to S corporations, pass-through entities, trusts and foreign entities. She can be reached at the CPA firm’s Ft. Lauderdale, Fla., office at (954) 712-7000 or via email at info@bpbcpa.com.
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