Around three out of four Americans say their finances are their number one source of stress in life. Do you fall into that category? If so, then you likely aren’t a fan of filing your taxes.
While none of us really enjoy this chore, neglecting your returns or making errors on them can have some serious consequences. For instance, did you know if you make a mistake when giving a payer your TIN, you could be subject to backup withholding?
We know what you’re thinking:
What is backup withholding?
Does this type of backup withholding tax apply to me?
We’re here to help. You can learn more about this nuanced tax rule below.
What Is Backup Withholding?
During the pandemic, many Americans had no choice but to seek out alternative sources of income. That meant more of us were working as independent contractors and freelancers. As a result, more people are interested in learning what backup withholding is and how it could impact their taxes this season.
Backup withholding is a method the IRS uses to make sure that all taxes are paid on sources of income specific taxpayers have improperly reported in the past. To do so, the IRS asks the payer to withhold a portion of payments, similar to the way an employer would do with your income check.
Does Everyone Pay IRS Backup Withholding Tax?
Most taxpayers don’t have to worry about backup withholding. That’s because most taxpayers provide the IRS with the correct details about themselves, and they also properly report all interest and dividend payments.
Payments Subject to Backup Withholding
Common tax FAQS often include questions about what payments are subject to backup withholding. Backup withholding applies to many sources of income that would get reported on either a W-2G or 1099 Form. Here are some of those types of payments:
- Income from gambling winnings (W-2G)
- Interest payments
- Attorney’s fees
- Rent, profit, or other income reported on Form 1099-MISC
- Royalty payments
- Payments for work you performed as an independent contractor
- Government payments you report on Form 1099-G
Are you still unclear about whether your payments are subject to backup withholding? Rather than make an error, reach out to tax attorneys who can answer your questions in detail.
Payments Excluded From Backup Withholding
Similarly, some payments are excluded from subject to a backup withholding tax. Here is a list of some payment types that you wouldn’t need to pay withholding tax on:
- State or local income tax refunds
- Canceled debts
- Long-term care benefits
- Qualified tuition program earnings
- Distributions from either retirement accounts or employee stock ownership plans
- Foreclosures and abandonments
- Real estate transactions
Identifying the type of payment you received and how it should get filed is one of the most common tax problems. If you’re struggling, don’t make the mistake of thinking you have to figure it out by yourself—there are resources available to help you!
What Does It Mean to Be Subject to Backup Withholding?
Backup withholding is a process whereby the IRS requires businesses to withhold a certain percentage of payments made to individuals or entities that are subject to backup withholding. The percentage withheld varies depending on the type of payment, but is generally between 24% and 28%.
Backup withholding is designed to ensure that taxpayers comply with their tax obligations. When a taxpayer is subject to backup withholding, the IRS has determined that the taxpayer has not paid all of the taxes they owe. This could be for a variety of reasons, including failing to pay taxes on income, not paying estimated taxes, or not complying with information reporting requirements.
If you are subject to backup withholding, it is important to take steps to ensure that you are in compliance with your tax obligations. Otherwise, you may face significant penalties.
How to Know If You Are Subject to Backup Withholding
Are you subject to backup withholding? One way to find out is to check your latest tax return. If you see that the section for “total payments subject to backup withholding” is checked, then you know that backup withholding applies to you.
You can also contact your employer or the payer of your pension or annuity. They should be able to tell you whether or not backup withholding is being deducted from your payments.
Finally, you can call the IRS directly at 1-800-829-1040—they can tell you whether or not backup withholding is in effect for you.
If you are subject to backup withholding, a portion of your payments will be sent to the IRS instead of being paid out to you. This can impact how much money you have available to spend or save.
How To Prevent or Stop Backup Withholding
Did you receive a notice in the mail about IRS backup withholding? If so, then you’re likely wondering how to prevent or stop backup withholding from happening. In some situations, you may be able to petition the IRS to stop their efforts, but it will take some work on your part. You’ll need to prove to the IRS that one of the following circumstances is true in your situation:
- You’ve corrected your error and filed an amended return, while also paying penalties or taxes.
- Backup withholding will create an undue financial hardship for you, and you’ll likely accurately report your dividends and interest in the future.
- The IRS was mistaken and you didn’t underreport interest or dividends.
- You’ve already been in contact with the IRS, which is investigating whether under-reporting happened.
If you believe one of the above is true in your case, it’s possible to stop backup withholding. If the IRS agrees with your claims, then they’ll send you a certification letter saying that the withholding is no longer necessary or that it will get stopped. The IRS will also contact any payers and let them know to stop their withholding efforts.
Do You Need Backup Withholding Help?
Understanding backup withholding tax rules is a real challenge. If you earned income through a 1099 for the first time due to the pandemic, you may have used an incorrect TIN, underreported your income, or failed to report certain sources of income by mistake.
Don’t continue to feel confused. Our team of tax consultants, tax attorneys, and CPAs can provide the backup withholding help you deserve. Contact us today to learn more about how we can help you with your past, present, and future tax needs.