FAQs about backup withholding on contractor payments

1. What does backup withholding mean?

Backup withholding is when payers (like businesses or individuals) are required to withhold a specific percentage of payments made to payees and send it to the IRS, which happens under certain conditions.

2. What’s the backup withholding rate and what causes it?

The backup withholding rate is 24%. Here’s what causes backup withholdings:

• If the payee’s Taxpayer Identification Number (TIN) is incorrect and does not match the IRS records or if they don’t provide you with their TIN at all.

• If the payee under-reports their interest or dividends on their income tax return. However, in this case, the IRS will proceed to withhold only after giving four notices within 120 days.

• If the payee doesn’t confirm that they’re not subject to backup withholding for under-reporting interest or dividends.

You must deduct and deposit the 24% of the payment from your payee until the backup withholding causes are fixed. If you fail to deduct the 24% from your payee, then you are liable to pay the amount to the IRS.

For more clarity on backup withholding reasons and rates, you can refer to this page about backup withholding from the IRS.

3. What payments are subject to backup withholdings and what are exempt?

Payments that might be subject to backup withholdings include:

• Interest and dividends
• Rents, royalties, and commissions
• Non-employee compensation (like payments to freelancers or contractors)
• Broker proceeds and barter exchanges
• Reportable gross proceeds paid to attorneys
• Certain payments from fishing boat operators

Payments that are excluded from backup withholdings:

• Real estate transactions
• Foreclosures and abandonment
• Canceled debts
• Distributions from retirement accounts, Archer MSAs, or ESOPs
• Long-term care benefits
• Fish purchases for cash
• Unemployment compensation
• State or local tax refunds
• Qualified tuition program earnings

4. What is a Taxpayer Identification Number (TIN)?

A TIN is either a Social Security Number (SSN) or Employer Identification Number (EIN) provided by the SSA or the IRS. A TIN can have nine numbers only and cannot have letters. While natives use TIN, non-natives use ITIN (Individual Taxpayer Identification Number) issued by the IRS for federal tax reasons.

5.  When is a TIN considered incorrect or missing?

The IRS considers a TIN to be missing if it has more or less than nine numbers, if there are letters in one of the nine places, or if it has not been provided at all.

Examples of correct format

SSN: 123-45-6789

EIN: 12-3456789

Examples of missing TIN

Missing SSN: 123-45-678 or 123-45-67899

Missing EIN: 12- 345678P

If the correctly provided TIN does not match the records in the IRS or SSA files, then it is considered incorrect.

6. How do I know if the payee’s TIN is incorrect?

If the payee's TIN is incorrect, the IRS will send you a CP2100 or a CP2100A Notice with all the incorrect TINs and names listed. You will get this after you submit your 1099 information returns with the IRS.

7. What is a CP2100 or CP2100A Notice?

A CP2100 or CP2100A Notice is issued to you (as the payer) to inform you that you are accountable for backup withholdings. This notice comes along with a list of missing or incorrect TINs. If you are a large-volume filer, you will get a CD or DVD data file as a CP2100. If you are a mid-sized filer you will receive a paper CP2100. If you are a small-size filer, you will get a paper CP2100A.

Here’s how the filer size is determined:

• If there are 250 or more error documents, you are a large filer.
• If there are 50 to 249 documents, you are a mid-sized filer.
• If there are less than 50 error documents, you are a small-sized filer.

8. What should I do if I get a CP2100 or CP2100A Notice?

If the TIN is missing:

• Start backup withholdings immediately, and continue to withhold until you receive a TIN from the payee. You should send up to three requests: initial, first annual, and then second annual, so there’s no penalty for not filing a TIN in the information return forms.

If the TIN is incorrect:

• For this, you can initiate a TIN request with the payee. If they agree, then send a B Notice. If the account holder does not agree, then the reasons could be a change in the SSA records, an error on your part when filing, or an error on the IRS while processing. If this type of error occurs, simply correct or update your records as needed.

9. What is a B Notice?

This is a backup withholding notice with two types: the First B Notice and the Second B Notice.

• First B Notice: You send this notice with Form W-9 after getting the first CP2100 or CP2100A Notice about an incorrect name/TIN combination.
• Second B Notice: You receive a second CP2100 or CP2100A Notice within three years. You mail this one without a W-9. It makes the payee contact the IRS or SSA to correct the name/TIN.

After issuing the Second B Notice, you should wait for confirmation from the IRS or the SSA that the correct name/TIN combination is established. You usually do not have to issue a B Notice more than twice in three years to the same payee.

10. When do I start or stop backup withholdings once I get a CP2100 or CP2100A?

You must start backup withholdings on all the payments you make to the payee within 30 days of getting your CP2100 or CP2100A Notice and must stop within 30 days of receiving the correct certification W-9 form, either from the payee or from the IRS or the SSA.

11. What form should I use to report backup withholdings?

Report backup withholdings with Form 945, the Annual Return for Federal Income Tax Withheld.

12. How should I treat erroneously withheld tax?

If you withhold more than the right amount, then you must refund the difference before the end of the calendar year and before you submit a 1099. If you are yet to file a 1099, but have not sent the extra amount to the payee, then you need not submit the excess amount to the IRS. If you’ve deposited the extra amount, then you can adjust that based on your next filings. The IRS allows refunds only if the error was on the payer’s side and not due to delays in getting the right TIN or certifications from the payee.

13. Why are some of the accounts that I corrected still on the list of missing or incorrect TINs?

The IRS will process the data based on certain schedules and deadlines. Due to these cut off points, your latest data may not reflect immediately. However, if you are sure that the account was corrected, do not send a B Notice to your payee.

14. What should I do if the TIN was actually there on the file but I missed it or reported it incorrectly?

In this case, do not send the payee a B Notice. Simply make the required corrections to your records and use the right TIN in your future filings.

15. When do I send a B Notice to a payee?

You should send a B Notice to a payee within 15 business days after receiving the CP2100A or CP2100 Notice or from the date on the notice, whichever is later. You must issue a B Notice only to payees whose name and TIN combination was determined to be incorrect by the IRS.

16. Does a CP2100 or CP2100A Notice show if it’s the first or second notice for an incorrect TIN?

The backup withholding regulations require the payers to stay aware of the status and does not show if it's the first or the second notice for an incorrect TIN.