A recent TIGTA report found that nearly $9 billion in backup withholding taxes are not being properly withheld by taxpayers. Based on its analysis of information returns reporting payments to payees with incorrect TINs, TIGTA determined that taxpayers were required to withhold nearly $9 billion from these payees and, in fact, withheld a mere $1-2 million. Just based on anecdotal experience, the conclusion (that taxpayers are not in compliance with the backup withholding rules) is not surprising—compliance with the rules has long been poor. But the sheer magnitude of the noncompliance is surprising.
The Tax Equity and Fiscal Responsibilities Act of 1982 and the Interest and Dividend Tax Compliance Act of 1983 require payers to backup withhold tax at a 28% rate from certain reportable payments. These acts require the payer of certain types of payments to deduct and withhold tax if:
- The payee fails to furnish a Taxpayer Identification Number (TIN) to the payer;
- The IRS notifies the payer that the payee name and TIN submitted to the IRS does not match its records;
- The IRS notifies the payer that a payee has underreported income from interest and dividends; or
- The payee fails to certify that they are not subject to backup withholding.
Subsequent laws added a number of reportable payments. Backup withholding can apply to most types of payments reported on Form 1099 where one of the criteria above is present. These include:
- Interest payments;
- Patronage dividends, but only if at least half of the payment is in cash;
- Rents, profits, or other income;
- Commissions, fees, or other payments for work performed as an independent contractor;
- Payments by brokers and barter exchange transactions;
- Payments by fishing boat operators, but only the part that is in cash and that represents a share of the proceeds of the catch;
- Payment Card and Third-Party Network Transactions;
- Royalty payments; and
- gambling winnings, if the winnings are not subject to regular gambling withholding.
When the IRS identifies information returns with missing or incorrect TINs, or determines that a taxpayer is subject to backup withholding, it sends the payer either a Computer Paragraph (CP) 2100 notice, Please Check Your Backup Withholding List, or a CP 2100A, Please Check Your Backup Withholding List. Depending on the identified issue, a taxpayer who received a CP2100 or CP2100A should seek professional help from a tax attorney, as time-sensitive (and often procedurally complex) steps may need to be taken in order to avoid incurring penalties or liability for amounts required to be withheld.