Exempt from Backup Withholding: What is Backup Withholding Tax?

Every year we file our taxes, and every year it seems to get more complicated. Even though the IRS spells out its tax regulations and gives us instructions, the amount of forms to fill and regulations to understand can become overwhelming— and it doesn’t get any easier when you receive a backup withholding notice. Tax laws change annually, so if you make even a simple mistake, you could be in danger of receiving a backup withholding notice. 

Thousands of taxpayers across the country face tax issues every year. Whether it be a lien, a garnishment, a levy, or worse, many taxpayers like you suffer from the same anxiety and distress. Taxes are one of the largest stressors in the U.S. and it can take a massive toll on both your personal and professional life. 

In this post, we’ll define backup withholding, discuss who’s exempt, what to do if you receive a notice, and more.

Who’s exempt from Backup Withholding Taxes?

U.S. citizens or resident aliens are considered exempt from backup withholding if their reported name and Social Security Number matches the IRS records. Additionally, you are exempt if you have not been notified by the IRS that you are subject to mandatory backup withholding.

When you receive a notice from the IRS, the envelope alone can be heart-stopping. Just seeing the title “IRS” emblazoned on the envelope can make you feel like the worst is about to happen, but this doesn’t need to be the case. No matter what your tax status or financial circumstance, the team at Community Tax can help you navigate your way to financial freedom.

What are Backup Withholding Taxes?

What is backup withholding

The IRS imposes a backup withholding tax when they have a discrepancy with the SSN or TIN that you or your employer provided. The backup withholding tax is only imposed by the IRS upon certain types of income as a “just in case” measure so that you do pay some of your taxes. For federal tax purposes, backup withholding is sometimes mandatory. Many people are exempt from and never experience backup withholding taxes, so many wonders what to do when they receive the notice in the mail. There are a few instances when you may be subject to a backup withholding, like when you fail to report or have provided an incorrect taxpayer identification number (TIN). Most payments that are reported on Form 1099 can be subject to backup withholding.

Payments from a Form 1099 are subject when you receive it from someone who doesn’t have your Social Security number. You may also recognize the phrase “subject to backup withholding” if you’ve ever filled out a W-9 form.

Your employer is always required to file a form with the IRS, whether it be a W2, a 1099-MISC, or a 1099-DIV. The IRS then uses these forms to verify that the income you reported matches the income your employer says you earned. If for any reason your name, SSN, or TIN don’t match each other, this causes trouble on behalf of the IRS when they process your return. This is why you should always double check your W-2 form around tax season to make sure they reported the right numbers.

What Money is Subject to Backup Withholding?

The purpose of a backup withholding tax is to ensure that you pay income taxes, regardless of whether you filled out a Form W-9 or if your information doesn’t match between you and your employer. Your employer is required to withhold some of your income before they pay it to you, just in case you owe the IRS.

As mentioned before, a backup withholding can apply to almost any payment that’s reported on Form 1099. They can take a flat rate of 28% on payments based on the following:

  • Commissions, fees, and other payments for work you perform as an independent contractor.
  • Dividends
  • Form 1099-G payments under IRC 6041 and 3406(b)(3)(A) which include taxable grants and agricultural payments (1099-G Box 6 or 7).
  • Gambling winnings
  • Interest payments
  • Original Issue Discount, if the payment is in cash
  • Patronage dividends
  • Payments by brokers/barter exchanges
  • Payment card and third party network transactions
  • Payment dividends (only if half the payment is in money)
  • Payments by fishing boat operators, but only the portion in money that represents a share of the proceeds
  • Royalty payments

Not all payments on a 1099 are included in backup withholding. Examples include abandonments, cancelled debts, distributions from Archer MSAs, distributions from retirement accounts, distributions from ESOP, foreclosures, fish purchases for cash, qualified tuition program earnings, state or local tax refunds, and unemployment compensation. If you receive a notice of backup withholding, take into account all of these factors to be sure that the IRS has the right amount covered. Not sure where to start? The team at Community Tax will help organize your finances and decipher whether the IRS is taxing you correctly.

Federal income tax withheld with 28 percent flat rate

When is Backup Withholding Required?

You may ask yourself, “Am I subject to backup withholding?” The answer depends on just a few boxes you fill out on the tax form your employer provides. The most common reason backup withholding is put into action is due to a mistake on either the tax payer or employer’s end. If you fail to provide your tax identification number (TIN) or SSN, backup withholding will start immediately (sometimes, people provide this information but don’t put it on the correct form, such as a W-9).

There are also times when people don’t understand what backup withholding means and thus fail to fill it out the section on the tax form. Whether a person decides not to report it or forgets to fill it out, they’re still subject to a backup withholding and it will implement itself right away. Another mistake taxpayers make is when they don’t report that they are not subject to backup withholding. If you don’t understand what a term means on a tax form you can prevent future headaches by looking it up through the IRS website or consulting a tax professional from Community Tax.

Employers sometimes log the wrong information into their records. Perhaps your handwriting wasn’t clear or the human resources department made a simple mistake. This is why you always contact your employer right away to address any discrepancies.

It’s also possible that the IRS made a mistake. It’s less common, but if the IRS notifies you that the SSN or TIN you reported is wrong, you can contact them anytime to clarify any errors. They may correct their mistake right away or explain to you where you made a mistake.

The IRS will always notify you if you underreported any interest or dividend payments. If you receive this notification you can count on backup withholding to start immediately.

What is a CP2100 or CP2100A Notice?

Whenever the IRS recognizes a discrepancy in your taxes, they will always notify you. Backup withholding is no different—the IRS will send you something called a CP2100 or CP2100A Notice right away to inform you that you may be responsible for backup withholding. The notice will always contain a list of missing or incorrect information. Individuals receive a CP2100A and large volume filers will receive a CP2100.

How to Prevent Backup Withholding

If you ever have any questions as to why you have backup withholding, the first step is contact your employer or contractor. Compare your information with theirs to ensure that all of the information is correct. You may be unaware that backup withholding has been set into motion, so check it every tax season when you receive your W-2. Correcting the problem will halt backup withholding right away.

Employers make mistakes, so if this happens you need to submit the appropriate “B” Notice to the payee. Sometimes the account won’t agree, which can be the result of an error in the information you entered, a result of a recent update, or an IRS processing error. In this case you should correct or update your records.

Should you have missing TINs, first determine if you are already have backup withholding on the account. If you aren’t, begin backup withholding immediately. Why? If you don’t enact backup withholding, you may suffer a penalty for not providing this information on your return. You must make up to three solicitations for the TIN to fix the problem including initial, first annual, and second annual.

You never need to call or write to the IRS if you made a correction or update, but do update your personal records.

Exemptions for tax withholding

Why Community Tax is Your Source for Tax Discrepancies

People make mistakes, but we don’t believe you should be punished for them. If you’re proactive about fixing errors right away, the IRS will work with you to clear you of a backup withholding debt. If you have a discrepancy with the IRS, whether it be a backup withholding issue or other tax matter, Community Tax should be your preferred source for your tax resolutions . Taxes only get more complex as you get older, so you should have a tax professional by your side to prevent frustration and penalties. You don’t need to handle your taxes on your own—our professionals have decades of combined experience helping clients maximize their tax refunds, keep financial records, and resolve tax issues with the IRS. Let us be your trusted source for tax help.

Don’t let unforeseen tax issues get you down. Contact Community Tax today and we’ll get our team to look at your financial records, get you out of tax trouble, and set up a promising financial future.

Backup Withholding FAQ’s

What is backup withholding tax?

Backup withholding tax is a type of tax that’s levied on payments that wouldn’t typically require withholding. Backup withholding is a way for tax-collecting agencies to ensure that the taxpayers pay the income tax they owe on investments. In the event that an investor has already spent income from investments, backup withholding ensures that investor can still pay their taxes.

While investment income is taxable at the time it’s received by an investor, those taxes don’t have to be paid until the end of the year. During that time period, investors could potentially spend all of the income that would be subject to withholding, leaving them unable to pay. Backup withholding tax is a simple way to make sure investors can pay taxes at the end of the year. However, some individuals are exempt from backup withholding, so it’s important to figure that out if you plan on investing.

How do I know if I am exempt from backup withholding tax?

Some individuals are exempt from backup withholding tax as a result of their standing with the IRS. If you’re considering investing, it’s important that you know whether you’re subject to backup withholding or not.

As a taxpayer, you may be exempt from backup withholding tax if you’ve provided the payer with your Social Security number and name through a W-9, and the number and name match the information that you’ve provided to the IRS.

If you are subject to backup withholding tax, the IRS will typically notify you to let you know. If you haven’t been notified that you’re subject to backup withholding tax, you may be exempt, so it’s important to check if you haven’t received a notice.

Why is my bank asking about backup withholding?

When you’re subject to backup withholding, you will typically receive some form of contact from your bank in addition to the IRS. If the IRS requires you to withhold taxes from each interest payment you receive, it’s easiest to do that through the bank that you’re using to receive those payments.

Upon opening a new investment account or making an investment at a bank for the first time, it’s important that you provide them with your name and TIN or SSN. As long as you provide an accurate W-9 to the institution you’re investing through, you don’t have to worry about backup withholding tax.

How do I stop IRS backup withholding tax?

The IRS decides an individual is subject to backup withholding tax based on that individual’s actions. If you’re subject to backup withholding tax, it’s because you provided incorrect information or failed to provide information that could have made you exempt.

The good news about backup withholding tax is that it’s fairly easy to stop for most people. All you have to do is correct the reason that you were subject to backup withholding in the first place, whether it was due to an incorrect TIN, failure to report certain income or failing to file a tax return.

If you’re subject to backup withholding and want to stop it, make sure you contact the IRS to figure out why. Oftentimes, getting your tax situation back to normal is as simple as making a quick phone call and providing a few pieces of information.

For more information on tax refund advice, tax resolution services, free consultations, and more, contact Community Tax today. Are you looking for a different tax form? More explanations and ideas to help you respond to IRS tax forms can be found in our tax form library.