What is Backup Withholding? What happens if TIN is Incorrect?

Hiring independent contractors is a great way to scale your business, but it comes with tax responsibilities. One of the most critical details when filing 1099 forms is ensuring the contractor’s Taxpayer Identification Number (TIN) is accurate. But what happens if the TIN is incorrect?
If the TIN is incorrect, the IRS may impose penalties and require you to correct the error. Additionally, you may be subject to backup withholding.

What Is Backup Withholding?

Backup withholding is a mandatory tax withholding that applies when a contractor provides an incorrect TIN or fails to provide one at all. The IRS requires payers (businesses) to withhold 24% of payments to the contractor and remit them directly to the IRS until the issue is resolved. 

What payments are subject to backup withholding?

There are several payment types, including:

• Commissions, fees, or other contractor payments 
• Attorney’s fees 
• Interest payments 
• Dividends 
• Payment card and third-party network transactions 
• Rents, profits, or other gains 
• Royalty payments 

When Does Backup Withholding Apply?

Your business must apply for it if: 

• The TIN provided is incorrect or doesn’t match IRS records. 
• The contractor fails to provide a TIN on Form W-9. 
• The IRS notifies you that the contractor is subject to backup withholding due to underreporting. 

Who is exempt from Backup Withholding?

Some independent contractors might be exempt from backup withholding. Exempt contractors include: 

• Tax-exempt organizations 

• Government agencies 

• Corporations 

To learn more about the exemptions, check out Instructions for the Requester of Form W-9. 

The Cost of Non-Compliance

Failing to apply backup withholding when required can result in IRS penalties for businesses. If a payer does not withhold when required, they may be liable for the full 24% withholding amount, along with additional fines and interest. Moreover, failure to file correct information returns can lead to further penalties ranging from $60 to $310 per form, depending on how late the correction is made. 

What If Backup Withholding Has Already Been Applied?

If backup withholding is already in place, businesses must: 

1. Continue withholding 24% from payments until the contractor provides a correct TIN. 
2. Report the withheld amounts on Form 945 (Annual Return of Withheld Federal Income Tax). 
3. Issue Form 1099-NEC or Form 1099-MISC to the contractor, reporting both the payments made and the amount withheld. 
4. Remit the withheld taxes to the IRS following the required deposit schedule. 

What Happens When Backup Withholding Is Overpaid?

When you overpay tax as a payer, the excess can be refunded to the payee, just like other federal income tax overpayments. Here’s how the process works:

1. Reporting Backup Withholding on Form 1099
   As the payer, when you withhold backup withholding tax from your payee’s income, you’ll report the amount withheld on an information return, such as Form 1099 (e.g., Form 1099-INT for interest income or Form 1099-MISC for miscellaneous income).
   This form provides the IRS and the payee with the total income paid and the federal income tax withheld during the year.
2. Ensuring Accurate Filing on the Payee’s Tax Return
   At the end of the tax year, your payee must file a federal income tax return, reporting all sources of income and any taxes withheld, including the backup withholding you reported on Form 1099.
   The amount you withheld and reported will be included as part of the total federal tax withheld for the year.
3. Checking for Overpayment
   During the tax return review process, the IRS determines whether the payee’s total tax liability has been covered by the amounts withheld throughout the year, including the backup withholding you handled.
   If the total tax withheld exceeds the payee’s tax liability, the IRS considers it an overpayment.
4. Issuing a Refund for Overpayment
   When an overpayment is identified, your payee becomes eligible for a refund.
   The IRS will issue the refund, which includes any backup withholding that was more than what they owed in federal taxes. 

How Tax1099 Simplifies TIN Verification & Compliance?

Manually verifying TINs and managing withholding can be time-consuming. Tax1099 helps businesses stay IRS-compliant by:

• Offering real-time TIN matching to detect errors before filing.
• Automating Form W-9 collection and validation, reducing manual work.
• Providing seamless e-filing for corrected 1099s if a mistake is made.
• Streamlining the reporting process, ensuring timely compliance.

FAQ’s

1) What is the backup withholding rate?

It’s 24%. Backup withholding is a safety net the IRS uses to make sure tax gets collected on certain payments that might otherwise go unreported.

2) What payments does backup withholding apply to?

Common ones include interest, dividends, rents, royalties, commissions and fees (including attorney’s fees), and certain broker/barter exchange payments. If a payment is normally reported on a 1099 and there is a TIN problem, backup withholding can be filed.

3) When do I have to apply backup withholding?

Start withholding if the payee’s TIN is missing or incorrect, if they don’t return a W-9, or if the IRS notifies you that the payee is subject to backup withholding (for example, because of underreporting). Act promptly- waiting can create liability.

4) What do I do once backup withholding applies?

Withhold 24% from the payment and keep withholding until a correct TIN is provided (or the IRS tells you to stop). Report the withheld tax on Form 945 (Annual Return of Withheld Federal Income Tax), and show federal income tax withheld on the appropriate 1099 you issue to the payee. Deposit the withheld tax on your regular deposit schedule (via EFTPS).

5) What happens if I don’t follow the rules?

You can be on the hook for the full 24% that should have been withheld, plus information-return penalties under IRC §§ 6721 and 6722. Those penalty dollar amounts are adjusted each year for inflation, so check the current IRS table.

6) What is the easy way to stay compliant?

To avoid mistakes, use TIN verification, collect W-9s automatically, and build in simple checks before you pay (all easy to do in tools like Tax1099).

Final Thoughts

Incorrect TINs can trigger backup withholding, penalties, and extra paperwork—a costly mistake for businesses. Protect your business by verifying contractor TINs with Tax1099 and ensuring smooth tax compliance.

Don’t risk backup withholding—start verifying TINs with Tax1099 today!
By taking proactive measures, you can ensure accurate reporting, avoid penalties, and maintain smooth contractor relationships while keeping your business IRS-compliant.

Start Verifying TINs