When you pay an independent contractor, you report the payment on Form 1099-MISC. You do not withhold and remit taxes from independent contractor wages. The contractor is responsible for handling the taxes.
But in some cases, you might have to implement backup tax withholding on a contractor’s pay. So, what is backup withholding, and when do you need to do it?
What is backup withholding?
IRS backup withholding requires you to withhold tax from payments that normally are not subject to withholding. Backup withholding ensures the government gets the taxes it is due.
Many types of payments are subject to backup withholding, including rents, royalties, interest, dividends, nonemployee compensation, etc. In this article, we’re going to focus on backup withholding on compensation you give to independent contractors.
The backup withholding rate is 24% of the contractor’s pay.
Who is subject to backup withholding?
You must start backup withholding on an independent contractor’s wages if
- the contractor gave you an incorrect taxpayer identification number (TIN) on Form W-9, or
- the IRS notifies you that the TIN is incorrect.
Is anyone exempt from backup withholding?
Some independent contractors might be exempt from backup withholding. Exempt contractors include:
- Tax-exempt organizations
- Government agencies
- Corporations (for some payments)
- Other entities listed in the Instructions for the Requester of Form W-9
The contractor should mark on Form W-9 that they are exempt from backup tax withholding.
What do business owners need to do?
When you hire an independent contractor, have the worker fill out Form W-9. Pay close attention to the TIN, which the contractor should include in Part I.
If the contractor refuses to give a TIN, start backup withholding immediately.
The TIN is also considered missing if it has more or less than nine numbers, or if there is an alpha character. Here are examples of incorrect TINs that are considered missing:
If the listed TIN is considered missing, begin backup withholding.
A TIN is also considered incorrect if it is listed in the right format on Form W-9, but it does not match or cannot be found in IRS or SSA files. In this case, you will receive a CP2100 or a CP2100A Notice that tells you to start backup withholding.
How you handle the backup withholding process depends on whether the TIN is missing or incorrect. View the flowcharts in IRS Publication 1281 to determine what actions you need to take.
Once the worker gives you the correct TIN, you can stop the backup withholding.
You must report the wages you withheld as part of IRS backup withholding on the annual Form 945. You must deposit the withheld wages throughout the year on either a monthly or semiweekly basis. Your depositing schedule is determined by how much you reported on the previous year’s Form 945. For more information about Form 945 and when to deposit the backup withholding, read the Instructions for Form 945.
If you do not follow the backup reporting rules, the IRS can penalize you, and you might be responsible for paying the uncollected amounts out of pocket.
To learn about backup withholding and all your responsibilities, check out Publication 1281.
State backup withholding
Some state tax agencies also impose backup withholding. To learn about your state backup withholding responsibilities, check with your state tax agency.
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This article is updated from its original publication date of 3/7/2017.
This is not intended as legal advice; for more information, please click here.