What Is Backup Withholding?
Backup withholding is a type of income tax withholding required in certain nonemployee payment situations. It typically occurs when a person or business receiving payment (the payee) either doesn’t provide a valid Taxpayer Identification Number (TIN) or the IRS notifies the payer that the provided TIN is incorrect.
Why Backup Withholding Happens and How to Avoid It
Backup withholding can be triggered by administrative or reporting issues, such as failing to furnish accurate taxpayer information or underreporting income. To avoid these deductions, currently held at a 24% rate through at least 2025, it’s essential for payees to verify their taxpayer details and keep their reporting compliant.
Backup Withholding Program Types
There are two IRS backup withholding classifications:
- BWH-B: Applies when a payee hasn’t submitted a correct TIN. Until the error is corrected, the payer must withhold 24% of applicable payments.
- BWH-C: Triggered by underreporting of dividend or interest income. The taxpayer has 120 days to correct the issue. If unresolved, the IRS mandates a 24% withholding rate on related payments.
What Types of Payments Are Subject to Backup Withholding?
This tax can apply to a broad range of non-wage income, including:
- Interest income
- Lottery or gambling winnings
- Dividends
- Legal settlements and attorney fees
- Profits from third-party network transactions
- Royalties and rental income
- Broker and barter payments
- Specific government disbursements
- Independent contractor fees
- Fishing boat cash payouts
- Redemption of some bond types (like zero-coupon bonds)
What Types of Payments Are Not Subject to Backup Withholding?
Certain income streams are exempt from backup withholding, such as:
- State/local tax refunds
- Retirement distributions (e.g., 401(k), IRA)
- Canceled debts
- Benefits from long-term care policies
- 529 plan earnings
- ESOP distributions
- Archer MSA withdrawals
- Payments for fish purchased with cash
- Unemployment compensation
- Foreclosure- or abandonment-related proceeds
Who Is Exempt From Backup Withholding?
Most U.S. citizens and resident aliens are not affected, provided their name and Social Security number (or EIN/ITIN) on file matches IRS records. Additionally, unless the IRS has sent a formal notification requiring backup withholding, individuals and businesses are not automatically subject to it.
Steps to Stop or Prevent Backup Withholding
If backup withholding has started, or if you’ve been warned it may, here are ways to resolve the issue:
- Correct your TIN: The most common trigger is an incorrect or missing Social Security Number, EIN, or ITIN. Submitting the correct number can stop future withholding.
- Report all income accurately: If interest or dividend income was left off previous tax filings, submitting amended returns and paying any associated taxes can help remove the withholding requirement.
- Catch up on overdue tax filings: If you’ve missed filing a tax return, resolve it as soon as possible. Filing late returns and settling outstanding balances can lead to the removal of the backup withholding status.
How Will You Know If You’re Affected?
Backup withholding isn’t applied silently, you’ll receive notification from either the IRS or the entity making payments to you. The communication you receive depends on which backup withholding program you fall under:
- Under BWH-B: You may receive one or more notices from the payer indicating your TIN is invalid. If unresolved, the IRS may prompt further verification through its own notices.
- Under BWH-C: The IRS sends up to four notices within a 120-day period if it identifies underreported interest or dividend income. If the situation isn’t corrected within that timeframe, a final notice will confirm that 24% of your payments will be withheld.
How Beyond Can Help
With platforms like Beyond, both businesses and individuals can manage tax compliance more efficiently. Beyond simplifies TIN collection, verifies data, and helps ensure tax forms are correctly filed, reducing the chances of backup withholding from occurring in the first place.