Backup withholding is the provisional withholding of a percentage of your income from investments, such as dividends or interest, to cover any income tax that you might owe. Normally your investment income is not subject to income tax withholding, like your salaries and wages are. But there are situations when the payers of your investment income are required to withhold taxes to ensure that income tax is collected on the income. This happens, for example, when the payer does not have certain information from you.
When backup withholding is required, the bank, broker, or other payer of interest, original issue discount (OID), dividends, cash patronage dividends, or royalties must withhold a percentage (28%, for example) of your income and pay it into the U.S. Treasury as income tax in your name.
When is Backup Withholding Required?
Backup withholding of income taxes will be required in the following cases:
When you did not give your social security number or employer identification number to the payer of your dividends, interest, or other investment income.
When you have given the payer an incorrect social security number or employer identification number and the Internal Revenue Service (IRS) notifies the payer of the incorrect number.
When you have under-reported interest or dividends on your income tax return and the IRS notifies the payer that you are subject to backup withholding because of this under-reporting.
When you are required to certify the reasons for which you are not subject to backup withholding, but you did not make this certification.
What You Can Do to Prevent Backup Withholding
When you know what triggers backup withholding, you will be able to prevent it before it starts.
When You Set Up an Account or Make an Investment
When you set up a new account or make an investment that will pay you interest, dividends, or other types of investment income, be sure to give the payer (bank, brokerage firm, or other financial institution) your correct social security number. The payer will give you a Form W-9, Request for Taxpayer Identification Number, or a similar form. Be sure to complete it, check your information to ensure that it is correct, and then turn it in. If you are opening an account or making an investment online, be sure you complete the necessary form and submit it. If you do not complete this certification form, backup withholding may begin immediately on your account.
When You File Your Income Tax Return
There are two different situations in which the IRS will determine that you have under-reported your interest and dividend income:
You filed a return but did not report all your interest and dividends that are required to be shown on your return.
You were required to file a return and report your interest and dividend income, but you did not file a return.
When you have interest, dividends, or other income from investments, check the requirements for who must file a U.S. individual income tax return. If you are required to file, be sure to include all interest, dividends, and investment income. Check the 1099 forms you receive, and the year end statements you receive on your investments, to find the total amount of income you have to report on your tax return for the year.
How to Stop Backup Withholding Once It Has Started
If you find that backup withholding taxes are being deducted from your interest, dividends, or other investment income payments, you will need to determine the cause of the withholding and take the necessary action to correct the situation that is causing it.
If the Backup Withholding is Due to an Incorrect Number
The financial institution where you opened your investment account may notify you of the backup withholding requirement. If so, provide them with the information they request. If you notice that backup withholding is being deducted from your income payments, but the financial institution has not notified you, ask them for a Form W-9 and provide the missing information or correct the information previously submitted.
If the Backup Withholding Is Due to Under-reporting Investment Income on Your Tax Return
If you have been notified that you under-reported investment income on your tax return, first you will need to determine whether you did, in fact, under-report your income. If so, you should file an amended income tax return, reporting all the income and the backup taxes that were withheld. The financial institution should give you an information return for the year, for example, a Form 1099-INT, that shows the income and any backup withholding taxes, reported as “Federal income tax withheld”.
If you should have, but did not file an income tax return, you should file one, reporting all your investment income and the backup taxes that were withheld. If you are filing past the deadline for the year, you may be subject to a late filing penalty.
Once you have filed a return, or an amended return, if necessary, or if you find that there was, in fact, no under-reporting, you will need to request a determination from the IRS to stop the backup withholding. You can do this through correspondence with the IRS, showing that at least one of the following situations applies in your case.
There was no under-reporting.
You have a bona fide dispute with the IRS about whether there was any under-reporting.
Backup withholding will cause or is causing an undue hardship on you and it is unlikely that you will under-report interest and dividends in the future.
You have corrected the under-reporting by filing a return, if you did not previously file, or you filed an amended return, and paid any taxes, penalties and interest due.
If the IRS determines that the backup withholding should stop, it will send you a certification of that fact, and will notify the financial institution where you have your account that they should stop the backup withholding.