If you are an employer or some other entity that makes payments, you must withhold taxes from your employees’ paychecks and certain other payments that you issue. However, you must also be aware of any additional taxes that you may have to withhold.
For payees who do not furnish a correct Tax Identification Number (TIN), you may be required to exercise the backup withholding tax rate.
If you fail to comply with the backup withholding rules, you are susceptible to being slapped with penalties. Additionally, you may be held liable for uncollected monies.
If you find yourself in this situation, here is what you will need to know in order to comply with the IRS.
Requirement to Obtain TIN
If you issue payments to employees or account holders, you must request the payee’s TIN using Form W-9, Request for Taxpayer Identification Number, when the employee or account holder is hired, opens an account or conducts a transaction. If the employee or account holder fails to provide you with his TIN, the IRS may inform you that you must take backup withholding taxes from the payment that you give to them. You are also expected to continue requesting their TIN.
If the payee provides a TIN but it is clearly the wrong format – such as the wrong number of digits or contains a letter – it is considered “missing”, just as if the payee had not provided you with a number at all. Additionally, if the TIN does not match IRS records, it is flat out considered “incorrect”.
When the Backup Withholding Rate Applies
If the employee fails to provide you with his correct TIN, you must take the backup withholding rate of 28% from certain taxable payments unless he is exempt. The IRS may also require you to extract these payments if the recipient has been underreporting his taxes.
Some payment types that might require backup withholding are rent payments, dividends, interest, royalties, and certain other payments that you issue while conducting business.
That being said, backup withholding does not apply to all types of payments. Some payment types are exempt, including wages, annuities, pensions, IRAs and other retirement accounts, pre-tax savings accounts, real estate transactions and long-term-care benefits.
IRS Notification of Backup Withholding
The IRS usually discovers that a taxpayer has a missing or incorrect TIN and is therefore subject to the backup withholding rate while processing 1099s. Once this determination has been made, the IRS will issue a CP2100 (for high-volume payers who have 250 or more payees with missing or incorrect TINs) Notice or CP2100A (for all other payers) Notice to the payer to inform him of the requirement.
If you receive the CP2100 or CP2100A Notice, you must send a “B” Notice to the named payee within 15 days of either the date you receive it, or the CP2100/2100A date – whichever comes later – and you must begin backup withholding within 30 days of that same date. Once the payee furnishes the TIN and certifies its accuracy, you must stop the withholding within 30 days. For more details on this process, view Publication 1281.
Once you have reported the backup withholding taxes to the IRS on Form 945, the payee will receive credit for this withholding when they file their tax return at the end of the year.
For more information on the backup withholding rate and payments, refer to the Instructions for Forms 1099, 1098, 5498, and W-2G and Publication 1281.
Additionally, it is always a good idea to consult a tax professional to ensure that you are in full compliance with the law.