Ever wonder why a portion of your income might unexpectedly disappear before it even hits your bank account? Well, the chances are highly of backup withholding. Don’t know what backup withholding is? Hang on! We will explain it all and how it impacts your cash flow in this blog.
What is Backup Tax Withholding?
Simply saying, it’s the portion of income your payer withholds at the command of the IRS (Internal Revenue Service). It’s different from regular wages, where your employer withholds and submits taxes on your behalf.
Basically, it’s your tax duty to report this income (investment-based) to the federal tax authorities. So, IRS backup withholding happens when you fail to report them accurately. More on it in the sections below!
Types of Payments Affected:
Payments that are fully or partially involved in investments are typically affected by backup withhold. Also, payments from non-employee compensation are sometimes affected. Here are payments that are majorly subject to backup withholding if not properly reported:
- Interests
- Dividends
- Freelancers & Contractors Payments
- Royalites
- Rents
- Certain Gambling Winnings
IRS’s Role in Backup Withholding Tax:
As we know, the IRS is the main Federal tax authority. They issue notices to payers, commanding them to back up withheld taxes of the payee. Ensuring the government gets its fair tax on the income earned by an investor.
The backup tax withholding happens when the IRS finds underreported taxes on income earned. Further, if the investor provides the wrong TIN (Tax Identification Number), the IRS issues a notice.
Why Am I Subject to Backup Withholding?
Most of the new investors receive a back up withholding notice and get confused about the reason. There can be multiple reasons why you are considered for tax backup, and below are some of the most common ones:
- Missing or Incorrect TIN: Wrong TIN (Tax Identification Number), SSN (Social Security Number), or ITIN (Individual Tax Identification Number) can trigger backup withholding. It halts the IRS’s ability to collect fair taxes on investment income, resulting in withholdings.
- Underreporting Interest/Dividends: If the IRS notifies you or your payer that you’ve underreported income from interest or dividends in the past.
- Failure to Certify: When you don’t certify on Form W-9 that you’re not subject to backup withholding.
- Notified Payee Underreporting: If the IRS has notified the payer to begin backup tax withholding on your payments due to previous underreporting.
Notices You Can Expect:
Typically, the IRS issues two types of notices over a period of 120 days (4 notices in total). These are:
- Notice B: IRS sends this notice for an incorrect or missing TIN / ITIN number.
- Notice C: This notice is sent if a payee has underreported income.
Quick Tip: Contact Tax King Service if you receive any of these notices and don’t know how to handle them. Our certified tax accountants will help you understand and report your tax obligations.
How to Prevent or Stop Backup Withholding?
Backup tax withholding means a portion of your income is blocked on the way. It can cause financial stress and issues. Here are some tips to avoid these kinds of financial blocks effortlessly:
- Provide a Correct TIN: To prevent backup withholding, always provide the correct TIN. Double-check it for errors and timely submit Form W-9. Get help from tax preparers if you find it time-consuming and complex.
- Respond to IRS Notices Promptly: Once you get the first notice, promptly respond to the IRS. Ignoring notices from Federal tax authorities can lead to backup withholding.
- Accurately Report Income: It is crucial to report all income correctly. As we discussed, underreporting is the main cause the IRS sends a BWH-B (Backup Withholding) notice, especially for interest and dividends.
- Certify When Required: Make sure to sign certifications on forms like W-9.
What to Do If You’re Already Subject?
There is nothing much you can do for already subjected to withholding. Your tax will be held for this year. However, you can contact the payer to provide the correct information. It will help you avoid future backup withholdings. Further contact with the IRS to resolve issues if there are underreported tax issues.
Is Backup Withholding an Additional Tax?
Not at all! Backup withholding isn’t an extra tax brick on your back! It’s basically a prepayment of your tax liability. The purpose is to avoid bankruptcy, say you spend all your investment income before the tax bill arrives. How will you handle that? So, to ensure you pay the right share to the government.
Also, the amount withheld is credited towards your total tax due. If it’s more than your tax obligations, don’t worry, you will receive a refund.
How Our Tax Preparation Services Can Help | Conclusion
Going through backup withholding all alone can cause a lot of stress. We have a well-experienced team of professionals who can help you understand why you might be subject to backup withholding. We also assist in taking necessary steps to stop it and ensure proper credit for any amounts withheld. Your money deserves to stay in your pocket, not withheld by any authority. So, make sure to take necessary steps to avoid it and call Tax King Service for help if you find your money withheld.
FAQs about Backup Withholding
Basically, regular tax withholding is done by your employer. They pay taxes on your behalf and provide you with a copy of the W-2 for personal records. On the other hand, backup taxes are held by organisations, credit unions and banks from where you collect investment incomes. They are not your employer nor have the authority to withhold backup withheld but these institutions can do so on IRS command.
It’s 24% based on IRS information. The rates are subject to change by official authorities.
Once the backup is withheld, there is nothing much you can do to reclaim it. However, you can claim credits on them when the tax bill arrives.
Yes, if the business is a payee, has a certain investment and meets the criteria.
Payments excluded from backup withholdings are real estate transactions, cancelled debts, payments made to an IRA, fish purchases for cash and unemployment compensations.
