What is backup withholding?

Types of backup withholding programs

By being familiar with the backup withholding rate, which will stay at 24% until at least 2025, and ensuring your taxpayer information is accurate, you can avoid withholding and keep your business finances in good shape.

There are two types of backup withholding programs: BWH-B and BWH-C. Here’s a brief overview of each one:

• BWH-B: BWH-B kicks in when the taxpayer fails to provide the correct TIN to the payer. Until the taxpayer corrects the TIN, the 24% backup withholding rate will apply.
• BWH-C: If the taxpayer underreports or fails to report all of their dividend and interest income, they’ll fall in the BWH-C category. They’ll have 120 days to resolve the issue, but if they don’t, the IRS will withhold 24% on their payments.

What payments are subject to backup withholding?

Backup withholding can apply to a variety of non-payroll income including:

What payments are “excluded” from backup withholding?

It’s important to keep in mind that certain types of payments are excluded from backup withholding, such as:

• Unemployment benefits
• 529 plan earnings
• State and local income tax refunds
• Retirement account distributions
• Long-term care benefits
• Canceled debts
• Employee stock ownership plan distributions
• Archer MSA distributions
• Fish purchased for cash
• Foreclosures and abandonments

Who’s exempt from backup withholding taxes?

Not everyone is subject to backup withholding taxes. US citizens and resident aliens are exempt from this tax provision as long as the name and Social Security number they report on their tax form matches IRS records. In addition, those who have not received a notification from the IRS do not have to worry about it.

How can you prevent backup withholding?

To prevent or stop backup withholding taxes, taxpayers must resolve the reason they became subject to it in the first place. They may have to:

• Provide the right TIN: The most common reason for backup withholding is failing to disclose the correct ​Social Security Number (SSN), Employer Identification Number (EIN), or Individual Taxpayer Identification Number (ITIN). The right TIN can quickly end this issue.
• Fix underreported income: Backup withholding may also arise if taxpayers don’t report all of their interest and dividend income. By reporting any unreported interest and dividend income and paying taxes on it if necessary, they’ll be able to remedy the situation.
• File past-due or missing tax returns: If a taxpayer hasn’t filed their tax returns or their tax returns are late, they should file them as soon as possible. Once they do so and pay any balances they owe, the IRS can remove the backup withholding mandate.

How do you know if you’re subject to backup withholding?

If backup withholding applies to a taxpayer, they should receive a notice from the IRS or their payer so they can potentially resolve the problem that led to the withholding. Notices depend on whether the backup withholding B or C program applies.

• BWH-B program: The payer may send one notice to the taxpayer that states their TIN is invalid and they need the right one. If the issue persists, they may send a second notice encouraging the taxpayer to check their TIN with the IRS or Social Security Administration.
• BWH-C program: With the C program, the IRS sends notices for unreported dividend and interest income. They send up to four notices over 120 days to inform the taxpayer of the situation. In the event there is no resolution, the IRS will send a final notice that states backup withholding will begin.