Backup Withholding (BWH)

What is Backup Withholding (BWH)?

It is expected of every taxpayer with certain kinds of income payments to report these payments on an information return (federal income tax return). The income payment types include; interest payments, dividends, payment cards, and third party networks, commissions, fees, or other payments received as a sole contractor, etc.

Definition of Backup Withholding

Backup withholding can be defined as a type of federal tax withholding on several types of income payments. It can also be said to be a kind of tax that is charged at a fixed tax rate on investment income.

Backup withholding ensures that the IRS or other government tax-collecting agencies will have access to all outstanding income taxes from investors’ earnings. In other words, backup withholding is a tax collection technique used by the IRS to collect all taxes on certain types of income that the taxpayer may have earlier used before their tax bill is due. In some situations, it is required of the taxpayer to withhold 24 percent – the current rate. The 24 percent is then taken out from any future income payments in order for the IRS to receive all tax due on the income.

Preventing Backup Withholding

There are two major causes that lead to backup withholding which are incorrect taxpayer identification number (TIN) under the BWH-B program, and failure to report interest and dividend income received on the payer’s federal income tax return under the BWH-C program. As regards the tax identification number (TIN), it could either be your individual taxpayer identification number (ITIN), employer identification number (EIN), or social security number (SSN). To prevent a backup withholding from (re)occurring the payer must correct the errors that can make them become subject to backup withholding such as providing the correct TIN, correcting underreported income and paying all outstanding taxes, and filing missing returns when necessary. U.S. residents (citizens and foreigners) can be exempted from being subject to backup withholding only if they properly report their names and social security numbers or tax identification numbers on the Form W-9; matching the information on IRS records.

Types of payments subject to backup withholding

Listed on forms 1099 and W-2G are the types of payments subject to backup withholding, they include:

• Payment Card and Third Party Network Transactions

• Interest PAYMENTS

• Payments by brokers/barter exchanges

• Dividends

• Patronage dividends

• Commissions, fees, and other payments received by individual contractors

• Rents, profits, or other gains

• Royalty payments

• Fishing boat operating payments

• Original Issue Discount

• Certain Government Payments

• Gambling winnings

Each of these payments is duly reflected in the sections they fall under such as the 1099-K, 1099-PATR, 1099-INT, 1099- DIV, 1099-MISC, 1099-OID,1099-G, and the W-2G. To be eligible to receive payments that can be reported on Form 1099 when you open an account and begin to receive payments or make investments you must duly provide your TIN in writing to the bank. In turn, you will receive a Form W-9 and Request for Taxpayer Identification Number and Certification in PDF format from the bank.

Payments not subject to backup withholding

• State or local income tax refunds

• Unemployment compensation

• Canceled debts

• Distributions from retirement accounts

• Distributions from employee stock

• Real estate transactions

• Foreclosures and abandonments

• Fish purchases for cash

• Long term care benefits