Skip to main content

Backup Withholding: Everything You Need To Know

Published February 4, 2021

4 minute read

Cora Walker

By Cora Walker

When it comes to paying taxes, you need to know what you’re doing. Making a mistake can be costly. Backup withholding is a process where a payer must hold back a portion of the payment to another person, in order to protect the IRS’s share. This usually occurs when you are paying someone who has supplied you with tax information that gets flagged or is obviously incorrect, particularly their Taxpayer Identification Number (TIN).

It’s important to know when you are required to start backup withholding, what kinds of income are subject to it, and when it’s okay to stop. Let us break it down for you.

How to Know if You Should Begin Backup Withholding

Basically, you need to begin backup withholding whenever there is an issue with tax information. It could be in information you were provided or the information that you gave.

Here is an example scenario to demonstrate. Let’s say you are an employer or a small business. You agree to pay a freelancer at least $600 for work they have done for you —  such as writing content for your website or a graphic designer creating marketing assets for you. However, when they give you their W9, their TIN either bounces or is obviously wrong.

That means that the IRS has no record of this person, who they will want to collect taxes from. That leaves you on the hook for the difference. You only need to begin backup withholding on future payments after you realize there is an issue. There are some other situations where you must begin backup withholding, but this is the most straightforward example.

On the other side, let’s say you are the freelancer in this example. If you supplied incorrect tax information (hopefully by accident), then the person or business paying you will begin withholding a portion of your payments. As a result, your pay stubs will be looking a little thin until you resolve the issue.

While freelancers typically handle their own taxes, this is one situation where employers will end up needing to withhold some of their pay. At least until the issue with their TIN is sorted out. If you are a small business that works with a freelancer enough that you are required to fill out a 1099-MISC form (meaning you have paid them at least $600 in the last tax year), you must begin backup withholding if there is a problem with the TIN or Social Security Number (SSN) on the W9 they sent you.

Backup Withholding “C” Program

Backup withholding may also be required for other taxpayers, including individuals. This is called “C” backup withholding. It kicks in if you underreported or misreported interest or dividend income on your federal tax return. If that happens to you, you will be to begin backup withholding.

Luckily, you will have plenty of time to correct it. In this situation, you would receive up to four notices over a period of 120 days in order to make the requested corrections. You must only begin backup withholding after the end of that 120 day period, assuming you can’t (or won’t) correct the problem first.

What You Need to Withhold

At the moment, the backup withholding rate is set at 24%. That means you must withhold 24% of the disputed amount or transaction. Please keep in mind that this number can change from tax code to tax code. If you must begin backup withholding, verify the amount that you must hold back by checking with the IRS.

When You Can Cease Backup Withholding

You can cease backup withholding (either as a payee or a payer) when the issue that caused you to begin backup withholding is resolved. In order to get credit for withheld income, you should report it on your 1099 or W2-G form for the year that you received the income.

If you are subject to backup withholding, it’s in your best interests to work to resolve the situation immediately. You certainly want all of your earnings back, but it also creates an additional resource strain for small businesses trying to sort out the problem. Businesses may be less eager to work with someone who provided erroneous information — even by accident. This is especially true if they then refuse to make any effort to correct it. If you are subject to backup withholding, getting out of that situation should become a major priority.

Kinds of Income Subject to Backup Withholding

Here is a small sampling of the kinds of income subject to backup withholding, should there be an issue.

Kinds of Income Not Subject to Backup Withholding

On the other hand, you will not need to enact backup withholding on all the money you send or receive. Here are some examples of situations where you will not need to worry about it.

The Bottom Line

They say that there are only two things in life that are inevitable: death and taxes. You can be very sure that the IRS will always want their cut. If things get murky due to a typo or paperwork error, backup withholding is the IRS’s way to cover their end. The easiest way to avoid being subject to backup withholding is to be extra diligent with your paperwork when working as (or working with) a freelancer. Keep your documents organized, tidy, and accurate. If you do that, you’ll be much less likely to be hit with a steep 24% backup withholding.

Restaurant owner calculating backup withholding

Shutterstock

Cora Walker

Cora Walker

Contributor

Cora is a Northwest-based writer and editor who wants to make information as accessible as possible in the internet age. Video games are this writer’s primary vice. With a degree from the University of Washington as well as 5+ years of experience in web writing and publishing, Cora is here to share financial tips from experts and talk about good habits.

Explore Taxes

Taxes

What Are The New 2021 Tax Brackets?

Each year, the Internal Revenue Service (IRS) updates their marginal income tax rates. In other words, they issue new tax brackets for the year ahead to reflect the ongoing impact of inflation. For 2021, there are seven income tax brackets in the United States: 10%, 12%, 22%, 24%, 32%, 35% and 37%. These will be […]

Read More about Post Title

7 minute read

Taxes

Payroll Tax Deferment Guide: Everything You Need to Know

On March 11, 2021, President Biden signed the American Rescue Plan Act into law. It’s a $1.9 trillion bill that extends many forms of federal assistance for businesses impacted by the Covid-19 pandemic. Two of the provisions found in the ARPT are the employee retention credit and the employer payroll tax deferral. These provisions are […]

Read More about Post Title

3 minute read

Taxes

Reasons Why Your Tax Refund is Delayed

The Internal Revenue Service is currently swamped. Despite that admission, you might still be anxiously waiting for your expected tax refund. The IRS says they have already processed more than 91 million individual returns from 2020. Additionally, more than 68 million refunds have already been issued to taxpayers. However, the agency is still holding more […]

Read More about Post Title

9 minute read

Taxes

How Much Money Do You Have To Make To File Taxes?

Every single year without fail, tax time returns. If you’re already a seasoned tax veteran, then don’t worry. This article probably isn’t for you. However, if you are young and just started your first job or barely made any money last year, you might be wondering “how much money do you have to make to […]

Read More about Post Title

4 minute read

quarterly tax payments Taxes

Do You Need to File Quarterly Tax Payments?

Whenever you get a new job, you’re required to fill out a W4 form. Your answers will help your new employer figure out how much tax to withhold from your paycheck. They will send that money to the IRS on your behalf. In most cases, these withholdings will cover your tax liabilities. Especially once you […]

Read More about Post Title

5 minute read

tax liability Taxes

What is Tax Liability and How Is It Calculated?

You’ve probably heard the phrase before and wondered “what is tax liability?” Simply put, a tax liability is the total amount of tax owed by a person or company to the government. In short, it’s the amount of money owed to the “taxman.” Tax is owed for a lot of different reasons. It’s most commonly […]

Read More about Post Title

5 minute read

Social Security Taxes Taxes

Are Social Security Payments Taxable?

Is social security disability taxable? It’s a question that a lot of people have asked. While the answer can be a bit complicated, in most instances Social Security benefits of any kind are subject to being taxed. Most Americans who receive Social Security benefits pay income tax on up to half (or even 85%) of that […]

Read More about Post Title

5 minute read

Tax Abatement Tax Incentive Taxes

Tax Abatement: Everything You Need to Know

A tax abatement is a reduction in the amount of taxes a business or individual must pay to the federal, state, or municipal levels of government. Tax abatements typically take the form of a decrease in the amount of tax owing or a rebate being issued. In some instances, an abatement can also result in […]

Read More about Post Title

4 minute read

See All In Taxes

More from WalletGenius

Budgeting

How To Plan Your 2021 Christmas Budget

As much as I love gift-giving and the holiday season in general, I often find that it sneaks up on me. If you’re anything like me, you often find yourself in mid-December scrambling to get presents bought, wrapped, and even mailed. That last minute scramble often means paying more for gifts than you intended, since […]

Read More about Post Title

7 minute read

Financial Advice

How To Avoid Paying These Hidden Fees

One of my good friends is a financial planner. He recently told me something very interesting about hidden fees. He basically said that his income comes from the fees that he charges his clients. They are typically based on a percentage of the client’s assets. That means that every quarter (or annually), those fees are […]

Read More about Post Title

8 minute read

Financial Advice

How Do You Justify Your Debt?

Most of us are well aware how debt works. We know we shouldn’t buy things that we can’t afford. Instead, we know we’re supposed to save up for major purchases. It’s just smart financial sense to not make a bunch of purchases that drive up your debt. However, when it all comes right down to […]

Read More about Post Title

8 minute read

Woman stressed from overworking Financial Advice

Are You Actually Working Too Much?

Our society just idolizes “more” for some reason. We often talk about the mentality of “keeping up with the Joneses” in the context of material possessions often. However, I’ve noticed lately that people are just as impressed with those who seem to be “doing” more — and no, not doing more at work. We also […]

Read More about Post Title

8 minute read

Woman working on her finances Financial Advice

Easy Ways to Simplify Your Finances

“Life is really simple, but we insist on making it complicated.” – Confucius Personal finance is surprisingly simple. Live below your means. Invest for the long term. Keep at it. Prosper. Yet, we instinctively want to complicate the process because we can’t trust that something so important can be so simple. I mean, how can […]

Read More about Post Title

7 minute read

Flipping Houses Home Ownership

How to Start Flipping Houses (And Actually Make Money)

House-flipping is often portrayed as a foolproof path to quick riches. While this inaccuracy can create unrealistic expectations, flipping houses can definitely be profitable if you do it right. And that’s the trick: the people most successful at flipping houses are generally the most experienced. That said, they all started somewhere. There’s nothing like completing […]

Read More about Post Title

6 minute read

TSP Loans Loans

TSP Loan: Everything You Need To Know

TSP loans are specialized loans designed for employees of the United States federal government. They offer federal employees access to a unique loan class that uses their retirement plans to finance their borrowing needs. Financial advisors often liken them to the 401(k) loans available to members of the general public. Yet, TSP loans differ from […]

Read More about Post Title

5 minute read

Trusted provider of accurate rates & financial information