What is Backup Withholding ? Who are Exempt from it?
What is backup withholding? is a good and common question for many. It is nothing but the tax deduction at source by the payer off certain kinds of payments. Under the Internal Revenue Code, persons making certain payments are required to pay only after withholding to 28% of such payments and depositing with IRS. This is the action of tax deduction at source by the payer is called “backup withholding.”
Payments Subject to Backup Withholding
Payments that may be subject to backup withholding include
- tax-exempt interest,
- broker and
- barter exchange transactions,
- nonemployee pay,
- payments made in settlement of payment card and third party network transactions, and
- certain payments from fishing boat operators.
How to prevent backup withholding?
Let us understand what makes it certain that the payments you receive will be subject to backup withholding. As per the IRS rule, in following conditions backup withholding is compulsory by the payer if:
- You do not furnish your TIN to the requester,
- You do not certify your TIN when required (see the instructions for Part II for details),
- The IRS tells the requester that you furnished an incorrect TIN,
- You do not certify to the requester that you are not subject to backup withholding under 4 above (for reportable interest and dividend accounts opened after 1983 only).
- If you do not report all your taxable interest and dividends on your tax return, IRS may notify you for backup withholding on payments of taxable interest and dividends.
Therefore, if you give the requester your correct TIN, make the proper certifications, and Are You exempt from tax withholding?
Are you as payee exempt from withholding?
Under the US Tax 26 , certain payees and payments are exempt from backup withholding. If you fall under any of the following List – 1, you are exempt from backup withholding from list given in (List 2)
List -1 – Payees Exempt
- An organization exempt from tax under section 501(a), any IRA, or a custodial account under section 403(b)(7) if the account satisfies the requirements of section 401(f)(2)
- The United States or any of its agencies or instrumentalities
- A state, the District of Columbia, a U.S. commonwealth or possession, or any of their political subdivisions or instrumentalities
- A foreign government or any of its political subdivisions, agencies, or instrumentalities
- A corporation
- A dealer in securities or commodities required to register in the United States, the District of Columbia, or a U.S. commonwealth or possession
- A futures commission merchant registered with the Commodity Futures Trading Commission
- A real estate investment trust
- An entity registered at all times during the tax year under the Investment Company Act of 1940
- A common trust fund operated by a bank under section 584(a)
- A financial institution
- A middleman known in the investment community as a nominee or custodian
- A trust exempt from tax under section 664 or described in section 4947
List -2 Types of Payments Exempt from Tax Withholding?
The following types of payments that may be exempt from backup withholding. The chart applies to the exempt payees listed above, 1 through 13.
IF the payment is for . . .
- Interest and dividend payments – All exempt payees except for 7
- Broker transactions Exempt payees 1 through 4 and 6 through 11 and all C corporations. S corporations must not enter an exempt payee code because they are exempt only for sales of noncovered securities acquired prior to 2012.
- Barter exchange transactions and patronage dividends Exempt payees 1 through 4
- Payments over $600 required to be reported and
- direct sales over $5,0001 Generally, exempt payees 1 through 5
- Payments made in settlement of payment card or third party network transactions
Exempt payees 1 through 4
See Form 1099-MISC, Miscellaneous Income, and its instructions.
Exception to List- 2
The following payments made to a corporation and reportable on Form 1099-MISC are not exempt from backup withholding:
- medical and health care payments,
- attorneys’ fees,
- gross proceeds paid to an attorney reportable under section 6045(f), and
- payments for services paid by a federal executive agency.