The potential for IRS backup withholding penalties should not be ignored! They are assessed by the IRS at 24% of everything you have paid to a vendor if you do not follow IRS requirements. For example, if you paid a vendor $1 million and the proper taxes were not withheld, the backup withholding penalty assessed to your company would be $240,000. The IRS would then assess additional penalties and interest for the failure to withhold and deposit taxes by the due date. And that would be for just one vendor!
In July of 2019, the IRS also increased its enforcement in this area by forming the Backup Withholding Enforcement Unit. This unit looks for differences between backup withholding reported in Box 4 on 1099 forms and the amounts reported on Form 945 as well as other discrepancies. The IRS is getting serious about backup withholding. In 2019 alone the IRS issued $6.2 billion in nonreturn penalties.
What is backup withholding?
Under certain circumstances, a company making payments in the normal course of their business to a U.S. vendor will be required to withhold 24% of all payments made to the vendor and remit the amounts withheld to the IRS. This is called “backup withholding”. The main trigger for backup withholding is when a company does not obtain the vendor’s TIN (Taxpayer Identification Number) before payment. A TIN is typically either the vendor’s Social Security Number or Employer Identification Number. Most companies use Form W-9 to obtain the TIN from their vendors. The TIN is then included on 1099 forms required to be filed with the IRS at the end of the year.
The primary reason the IRS requires backup withholding is to ensure that all 1099 forms include a TIN. This allows the IRS to match the payments reported on the 1099 forms with the income reported by the vendors on their tax returns. The IRS uses this payment information to verify that vendors report all the income they have earned and pay the correct amount of income tax. By requiring 24% to be withheld the IRS ensures that any tax is paid in advance if a TIN is not provided. This ensures that the IRS collects the tax owed. It puts the ball in the vendor’s court to go to back to the IRS and get any overpayment refunded.
Get a correct and complete W-9 form from every vendor before making a payment. It’s as easy as that to avoid most backup withholding requirements!
Do you have a process in place to ensure that you have a correct and complete W-9 form from each vendor before payment? That is one of the primary reasons we created W9manager. W9manager connects directly to your accounting system and captures every vendor as created. A W-9 request is then automatically sent out to each vendor with four additional reminders. The vendor uses our guided, step-by-step process to help them submit a correct and complete W-9 form. And you can see the W-9 status for every one of your vendors at any time. With plans starting at $69/year for 75 W-9 requests, W9manager is affordable for any size company. Don’t risk paying 24% in backup withholding penalties!
What payments are subject to backup withholding?
Backup withholding can apply to most kinds of payments reported on Forms 1099 and W-2G, including:
- Interest payments (Form 1099-INT)
- Dividends (Form 1099-DIV)
- Payment Card and Third Party Network Transactions (Form 1099-K)
- Patronage dividends, but only if at least half the payment is in money (Form 1099-PATR)
- Rents, profits, or other gains (Form 1099-MISC)
- Commissions, fees, or other payments for work you do as an independent contractor (Form 1099-NEC)
- Payments by brokers/barter exchanges (Form 1099-B)
- Payments by fishing boat operators, but only the part that is in money and that represents a share of the proceeds of the catch (Form 1099-MISC)
- Royalty payments (Form 1099-MISC)
- Gambling winnings (Form W-2G) may also be subject to backup withholding.
- Original issue discount reportable on (Form 1099-OID), Original Issue Discount, if the payment is in cash
- Certain Government Payments, Form 1099-G
What payments are excluded from backup withholding?
Payments that are excluded from backup withholding include real estate transactions, foreclosures and abandonments, cancelled debts, distributions from Archer MSAs, long-term care benefits, distributions from any retirement account, distributions from an employee stock ownership plan, fish purchases for cash, unemployment compensation, state or local income tax refunds, and qualified tuition program earnings.
What specific situations require backup withholding?
Payments made will be subject to backup withholding if:
1. A TIN is not provided to the requester,
2. The TIN is not certified (signed) when required (see the Part II of the W-9 instructions, page 3 for details),
3. The IRS tells the requester that an incorrect TIN was furnished.
4. The IRS tells the entity or individual receiving the payment that they are subject to backup withholding because they did not report all their interest and dividends on their tax return (for reportable interest and dividends only)
5. The entity or individual does not certify to the requester that they are not subject to backup withholding under 4 above (for reportable interest and dividend accounts opened after 1983 only).
Certain payees and payments are exempt from backup withholding. See Exempt payee codes on page 3 of Form W-9 and the separate Instructions for the Requester of Form W-9 for more information. Generally, individuals (including sole proprietors) are not exempt from backup withholding.
Disclaimer – Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.