In accounting terminology, withholding means taking out taxes from a payment in advance. Paychecks usually have both income taxes and FICA taxes withheld, and gambling winnings like bingo or the lottery over $600 also have income taxes withheld. However, taxes are generally not withheld in the U.S. for other types of potentially taxable payments like dividends, interest income and so forth. That said, these payments can be subject to backup withholding under some circumstances.
Reasons for Backup Withholding
IRS Tax Topic 307 - Backup Withholding states that reasons for requiring backup withholding include the taxpayer not providing a correct taxpayer identification number (TIN) or having a history of under-reporting taxable income.
Organizations Exempt from Backup Withholding
IRS regulations make a number of organizations exempt from backup withholding regulations. These organizations include various tax-exempt organizations such as 501(c) nonprofits, government agencies and most corporations. A complete list of payees who may be exempt can be found in the Instructions for the Requester of Form W-9.
Amount of Backup Withholding
IRS regulations require that payers withhold backup withholding from payees at a flat rate of 28 percent. Taxpayers subject to backup withholding, of course, receive credit for taxes paid and may get some of the backup withholding back as a tax refund depending on their total taxable income and other withheld taxes.
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Duration of Backup Withholding
The duration of the backup withholding varies from case to case. Many cases of backup withholding are just a matter of typos or transcription errors and are usually resolved relatively quickly by supplying the correct TIN, but backup withholding as a result of chronic under-reporting of income may continue indefinitely.