Backup Withholding: What It Is and How It Works

What is backup withholding?

Backup withholding is a federal tax mechanism that requires payers (banks, brokers, and other payers) to withhold a portion of certain payments and remit it directly to the IRS. Its purpose is to ensure the government collects income taxes owed on payments—often investment income—that taxpayers might otherwise spend before filing their tax returns.

The current backup withholding rate is 24%.

How it works

• When a payer makes reportable payments (for example, interest or dividends) to a payee, it typically collects the recipient’s Taxpayer Identification Number (TIN) using Form W-9.
• If the payer does not have a correct TIN, or the IRS notifies the payer that the payee underreported interest or dividends, the payer must withhold 24% from those payments and remit it to the IRS.
• Amounts withheld under backup withholding are treated as tax payments and can be claimed as credits when the payee files their federal income tax return.

Payments that may be subject to backup withholding

Common payment types that can be subject to backup withholding include:
– Interest
– Dividends
– Rents and royalties
– Commissions and fees for independent contractors
– Gambling winnings (in some cases)
– Patronage dividends (reported on Form 1099‑PATR)
– Payments from brokers on securities transactions
– Payments from fishing boat operators

Generally, backup withholding applies to payments reportable on Form 1099.

Reasons backup withholding is imposed

Backup withholding is typically triggered for one of the following reasons:
– The payee failed to provide a correct TIN (for individuals, usually a Social Security number) to the payer.
– The payee failed to certify that they are not subject to backup withholding when required.
– The IRS notifies the payer that the payee underreported interest or dividend income.

Before imposing withholding, the IRS provides notice to taxpayers and gives them an opportunity to correct the issue.

Who is exempt

Certain payments and payees are exempt from backup withholding, including:
– Retirement account distributions and unemployment compensation (these are not subject to backup withholding)
– Payees who have provided a correct TIN that matches IRS records and who have not been notified by the IRS as subject to backup withholding
– Some other payees or payment types specified by the IRS

Most U.S. taxpayers who furnish a correct TIN on Form W‑9 to their broker or payer are not subject to backup withholding.

What to do if you’re subject to backup withholding

• Provide the correct TIN to the payer using Form W‑9 if you haven’t already.
• Respond to any IRS notices asking you to verify or correct reported income.
• If backup withholding occurs, report it on your federal income tax return; the withheld amount is credited against your total tax liability and may result in a refund if it exceeds the tax due.

Bottom line

Backup withholding is a safeguard the IRS uses to collect taxes on certain payments—especially investment income—when there is risk that taxes might not otherwise be paid. It reduces short-term cash for the payee but is not additional tax; withheld amounts are credited on the taxpayer’s annual return. To avoid backup withholding, ensure your payer has a correct TIN and respond promptly to any IRS notices.