What is Backup Withholding? Rates

The federal law requires payers, whether they are employers or companies, to withhold federal income taxes when necessary. Employers withhold federal, state, and local income taxes from their employee’s paychecks. However, these taxes are not subject to withholding from the income paid to freelancers and independent contractors – at least in most cases. 

There are certain situations where income paid to these individuals may be subject to tax withholding. This happens when the person or the company doesn’t state who they are through filing a W9 tax form. This tax form details important information like the Social Security number or other taxpayer identification number of the individual or the entity. 

Backup withholding rate

This information provided with the W9 tax form allows the payer to file the necessary tax forms – more specifically, information returns to report the income. When these details are not provided, the payer simply cannot report them. In this situation, the payee will be subject to backup withholding. 

Due to the nature of the tax withholding, considering this is not from an employee’s paycheck where the employer would figure it out using the W-4 given by the employee, there is a fixed rate. For the 2022 tax year, the IRS has set the backup withholding rate at 24 percent.

How to report to the IRS?

The same as you report any other transaction related to your business, you must report the backup withholding to the Internal Revenue Service. Do this the same way you report other payments by filling out Form 941. Also known as the employer’s quarterly federal tax return, Form 941 has a dedicated space to report backup withholding. 

After withholding the taxes and including them on Form 941, forward the proceeds to the IRS according to how you send the other taxes withheld. 

Amount subject to backup withholding

Figuring out the amount in which you’re going to take the taxes out front can get tricky. Just like how you withhold federal, state, and local income taxes from your employees’ paychecks, you account for the gross payment made to the payee. 

For example, assume you’ve paid $600 from an agreement to pay $2000 in total the next month. Since you paid $600 in advance doesn’t mean you are going to exclude it from the amount subject to backup withholding. Take out federal income taxes from the total payment that’s made or will be made to the payee, not just the remaining amount.