If your broker sent you a dividend or interest check, but the amount you received is 24% lower than expected, then “backup withholding” likely is to blame. The brokerage was required to send that missing money to the IRS.
Bottom Line Personal asked tax expert Abby Eisenkraft to answer taxpayers’ big backup-withholding questions, including “Am I subject to backup withholding?” and “How can I stop IRS backup withholding?”
Why am I subject to backup withholding?
Payments can be subject to backup withholding for two reasons…
The payer does not have the recipient’s Social Security number or other tax identification number. This happens when someone fails to provide tax identification information to the institution making the payment…or when someone provides inaccurate info, perhaps mis-entering a digit on a brokerage account form.
The recipient has underreported interest and/or dividends on a previously filed federal tax return. If a taxpayer fails to resolve this issue following multiple IRS warning letters, the IRS will inform banks, brokerages and other institutions to subject this individual to backup withholding. Related: When someone opens an account with a financial company, the new account paperwork typically includes the question, “Are you subject to IRS backup withholding?” The account likely will be subjected to backup withholding if you don’t answer this question or you answer “yes,” whether or not that affirmative response is accurate.
What payments are subject to backup withholding?
Backup withholding is most common with dividend and interest payments, but it also can apply to other forms of payments reported on a Form 1099, such as commissions, independent contractor income, royalties and rental income. It also can apply to casino gambling winnings.
Payments specifically excluded from backup withholding include cancelled debts, long-term-care benefits, distributions from retirement accounts, unemployment benefits, and state and local tax refunds.
How can I stop backup withholding once it’s started?
If the backup withholding is occurring because the payer lacks the recipient’s correct Social Security number or other taxpayer ID, the solution is simple—provide this info to the payer.
If the backup withholding is due to previously unreported or underreported interest or dividends, it might be necessary to file or amend earlier tax returns and correct earlier tax underpayments.
Neither of these solutions is likely to undo backup withholding that has already occurred—that money has probably already been remitted to the IRS—but they can prevent additional withholding from occurring.
Good news: Backup withholding is not an additional tax, and it does not increase your overall tax bill. It is simply how IRS gets what it’s owed. Taxpayers who are subject to backup withholding report the amounts withheld on their tax returns. If the 24% backup withholding rate turns out to be higher than the tax rate the taxpayer actually owes on a payment, he/she will receive a higher tax refund or face a lower year-end tax bill to balance things out.
