Definition
Backup withholding is a tax mechanism in the United States designed to ensure that individuals who fail to provide a valid taxpayer identification number (TIN), such as a Social Security Number (SSN), to the payers are still paying taxes on their nonwage income. Incentivizing compliance, the IRS mandates that payers (like banks or brokers) withhold a certain percentage of the payment, typically 24% post-2012 amendments, rising from a previous rate of 28%. The withheld amount must be remitted to the federal government. This withholding requirement is documented on IRS Form 1099, a form used to declare nonwage earnings like interest and dividends.
Examples
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Scenario with Interest Payments: A bank pays interest on CDs (Certificates of Deposit) to a customer but does not have the customer’s SSN. The bank would then withhold 24% of the interest payment and submit it to the IRS as backup withholding.
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Dividends from Brokerage Accounts: An individual receives dividend payments from their brokerage account but fails to supply a Social Security number. Consequently, the brokerage firm deducts 24% of the dividends for backup withholding.
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Freelance Payments: A freelancer is paid by multiple clients totaling more than $600, but neglects to provide an SSN. The clients are required to withhold 24% of the payments for IRS purposes.
Frequently Asked Questions
What triggers backup withholding?
Backup withholding is triggered when a taxpayer fails to provide a correct taxpayer identification number (TIN) or if the IRS notifies the payer that the taxpayer is subject to backup withholding.
What type of income is subject to backup withholding?
Backup withholding generally applies to nonwage income such as interest, dividends, rents, royalties, non-employee compensation, and certain other payments.
How does a payee stop backup withholding?
Once a correct TIN is provided or other corrective actions taken and proper documentation submitted to the IRS, backup withholding can be stopped.
What is IRS Form 1099?
IRS Form 1099 is a series of documents the IRS refers to as “information returns.” Commonly it reports nonwage earnings for taxpayers.
Are there any exceptions to backup withholding?
Yes, exceptions are provided under specific circumstances, such as payments made to corporations, tax-exempt organizations, the United States, a state or local government, or international organizations.
Related Terms
- TIN (Taxpayer Identification Number): A unique number assigned by the IRS or Social Security Administration used for tax purposes.
- Form W-9: An IRS form used by taxpayers to confirm their TIN to the entity that will file an information return with the IRS.
- Nonwage Earnings: Income, other than wages, which includes interest, dividends, rent, royalty, or other income reported on 1099 forms.
- Withholding Tax: An advance payment on a taxpayer’s income tax liability deducted by the payer and remitted directly to the government.
Online References
- IRS Backup Withholding Information
- Understanding IRS Form 1099
- Federal Backup Withholding Guidelines
Suggested Books for Further Studies
- “Taxation for Individuals 2021 Edition” by Joseph Bankman, Daniel N. Shaviro, Kirk J. Stark
- “Individual Income Taxation: An Application Approach” by Marvin A. Chirelstein
- “Federal Income Taxation, 17th Edition” by Paul R. McDaniel, Martin B. Dickinson, James J. Freeland
Fundamentals of Backup Withholding: Taxation Basics Quiz
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