What Is Backup Withholding?

Have you ever received a payment — such as a dividend check or a bond interest payment — and noticed that 24% of the expected amount was missing? If so, you may be subject to backup withholding.

This tax action can be irritating, but it only applies to certain kinds of payments and is easily fixed by making sure the IRS has correct tax information from you.

What is backup withholding?

Backup withholding is an action where the IRS makes payers, such as banks, deduct a 24% tax from certain kinds of payments to taxpayers who have failed to provide the IRS or payers with needed information and send that amount to the government. It’s a way of ensuring the IRS receives the money it’s owed by potentially uncooperative taxpayers.

There are two ways someone can become subject to backup withholding:

• The backup withholding “B” program applies to taxpayers who fail to provide a correct tax identification number (TIN) to entities that pay them — for example, a bank at which they have a high-yield savings account. A TIN can be a Social Security number, an employer identification number or an individual taxpayer identification number. (Payers need a valid TIN from payees so that they can accurately report payments to the payee to the government.)

• The backup withholding “C” program applies to taxpayers who have unreported interest or dividend income on their federal tax return, or who have accidentally marked themselves as subject to backup withholding due to previous underreporting of income. (Many investment institutions, such as brokers, are required to ask new users if they’re subject to backup withholding. If a user mistakenly checks that box, they may become subject to it.)

If you’re subject to backup withholding, that 24% deduction counts toward your taxes owed. You may be able to get some of it back if you file a Form 1040 that shows that the amount you’ve paid via backup withholding is greater than the amount you owed for a particular year.

What payments are subject to backup withholding?

Backup withholding can apply to many different kinds of nonpayroll income — typically the kind of things that are reported on a 1099 form, which records passive income and nonsalary work, or a W-2 G form, which records gambling winnings. These include:

• Interest payments.

• Dividends.

• 1099-K income from credit or debit card payments.

• Independent contractor work income.

• Attorney’s fees and court proceeds, for attorneys.

• Patronage dividends from co-op businesses.

• Rents, profits and other capital gains.

• Payments from brokers.

• Royalty payments.

• Cash payments from fishing boat operators.

• Certain government payments.

• Redemptions of certain types of bonds, e.g., zero-coupon bonds.

• Gambling winnings (reported on form W-2 G).

But backup withholding doesn’t apply to all nonpayroll income. Certain kinds of payments are excluded from it, such as:

• Retirement account distributions.

• Long-term care benefits.

• Employee stock ownership plan distributions.

• Debt relief.

• Abandonments and foreclosures.

• Archer MSA distributions.

• Cash sales of fish.

• Unemployment benefits.

• Local and state income tax refunds.

• Real estate transactions.

• 529 plan earnings.

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

If you’re subject to backup withholding, you should receive at least one letter notifying you of backup withholding before it starts. But which letter you receive and who it comes from depends on which specific backup withholding program you’re subject to.

Backup withholding “B” program notification

If you’re subject to “B” backup withholding, the payer you failed to provide a valid TIN to will send you notices asking for you to provide the missing information. The IRS, however, will not send you a notice — they will send a notice to the payer, who will then reach out to you.

If you provided an obviously incorrect TIN (e.g., one that doesn’t have enough numbers) or you didn’t provide one at all, backup withholding may begin immediately. For example, if you fail to provide a TIN while signing up for an online savings account, backup withholding of interest payments may begin upon account opening.

If there’s just a discrepancy between the name and TIN you provided, you may have up to 60 days to correct the issue before backup withholding begins.

Backup withholding “C” program notification

If you’re at risk of becoming subject to “C” backup withholding due to unreported interest or dividend income, the IRS will send you up to four notices over a 120-day period asking you to correct your income tax return to account for the unreported income. If you don’t make those corrections, the final notice informs you that you’re now subject to backup withholding.

If you become subject to “C” backup withholding because you failed to certify that you’re not subject to it, you will not receive a notice from the IRS, and backup withholding may begin immediately. For example, if you accidentally checked the “backup withholding” box while signing up for a brokerage account, backup withholding may begin upon account opening.

If you want to contact the IRS about backup withholding, you can call them at 800-829-1040 from 7 a.m. to 7 p.m. local time.

How to stop backup withholding and get credit for it

Backup withholding doesn’t have to be permanent. If you end up paying more than you actually owe, it can be partially refunded, just like any other tax payment. But the details of how to stop backup withholding vary based on which program you’re subject to.

How to stop “B” backup withholding

Stopping “B” backup withholding is simply a matter of sending the payer a W-9 form with a correct TIN. The payer may send you a W-9 form when they notify you of intent to begin backup withholding. If not, you can download it yourself here.

How to stop “C” backup withholding

To stop “C” backup withholding due to unreported interest or dividend income, you’ll need to report that income — and pay taxes on it, if applicable.

That might mean filing missing or past-due tax returns, for which you’ll need to find the appropriate Form 1040 for the appropriate prior year on the IRS website. Or it might mean filing an amended tax return with Form 1040-X, which you can download here.

If you’ve become subject to “C” backup withholding accidentally, due to an error while filling out a form, contact the customer service department of the relevant bank, brokerage or other payer institution and see if they can help. They may ask you to send them a new W-9 form to stop backup withholding.

How to get credit for past backup withholding