What is backup withholding tax?

Definition and Purpose of Backup Withholding Tax

Definition of Backup Withholding Tax:
Backup withholding tax is a form of tax withholding on income that typically is not subject to withholding. It is a measure used by the IRS to ensure that the government is able to collect taxes on all appropriate income, especially when certain conditions are not met by the taxpayer.

Purpose of Backup Withholding Tax:
The primary purpose of backup withholding is to secure tax revenue for the government from certain payments that are reported on forms such as 1099 and W-2G. It acts as a safeguard against underreporting and non-reporting of income by individuals and businesses.

Situations Triggering Backup Withholding:

1. Incorrect Taxpayer Identification Number (TIN):
  - If an individual or business fails to provide a correct TIN, which can be a Social Security Number (SSN), Employer Identification Number (EIN), or Individual Taxpayer Identification Number (ITIN), backup withholding may be required.

2. Underreported Income:
  - If interest and dividend income is underreported on a federal income tax return, or if the taxpayer fails to certify that they are not subject to backup withholding for underreporting interest and dividends, backup withholding may be applied.

3. Specific Payments Subject to Backup Withholding:
  - Payments such as interest (Form 1099-INT), dividends (Form 1099-DIV), rents, profits, royalties, and certain other gains (Form 1099-MISC), as well as payment card and third-party network transactions (Form 1099-K), are examples of income that may be subject to backup withholding.

How to Prevent or Stop Backup Withholding:

- To prevent or stop backup withholding, taxpayers must correct the reason they became subject to it. This may involve providing the correct TIN, resolving underreported income, paying the amount owed, or filing any missing returns.

Reporting Backup Withholding:

- If income tax has been withheld under the backup withholding rule, it should be reported on the tax return for the year the income was received, using the appropriate forms that show federal income tax withholding.

Payments Excluded from Backup Withholding:

- Certain types of payments are excluded from backup withholding, such as real estate transactions, distributions from retirement accounts, and others specified by the IRS.

By adhering to these guidelines, individuals and businesses can ensure compliance with tax laws and avoid unnecessary withholding on their income.

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Sources:

Backup Withholding | Internal Revenue Service 2024-08-02

Topic no. 307, Backup withholding - Internal Revenue Service 2024-08-01

Topic no. 553, Tax on a child's investment and other unearned income ... 2024-08-03

Digital assets | Internal Revenue Service 2024-08-02

Instructions for the Requester of Form W-9 (Rev. March 2024) 2024-08-03

Publication 15 (2024), (Circular E), Employer's Tax Guide 2024-08-03

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Notice 2014-21 SECTION 1. PURPOSE - Internal Revenue Service 2024-08-02

Part III - Internal Revenue Service 2024-08-02