Do you have a backup plan? The IRS does too. The plan is called backup withholding, which became part of the tax code when two separate laws were enacted in 1982 and 1983. The rule requires payers to withhold federal income tax on certain payments in four situations.
1. When the payee fails to furnish a taxpayer identification number
2. When the IRS notifies the payer that the payee name and number does not match IRS records
3. When the IRS notifies the payer that a payee has underreported income from interest and dividends
4. When the payee fails to certify that they are not subject to backup withholding
In September 2016, the Treasury Inspector General for Tax Administration (TIGTA) issued a report that concluded billions of dollars of backup withholding were not being withheld. TIGTA said IRS enforcement of the rules was lacking, and offered suggestions for how the IRS could correct the problem.
The IRS agreed with most of the recommendations, and notified TIGTA of corrective actions that will be taken. The IRS assigned implementation dates in 2017 to these actions, and it’s likely you will be hearing more about backup withholding in the coming months.
Here are questions to test your knowledge of backup withholding.
The TIGTA report was released in 2016 and covers tax year 2013. During tax year 2013, the IRS received 1,446,429,153 information returns with reportable payments that may be subject to backup withholding.
Of those, 1,101,514,668 were Form 1099-B, Proceeds From Broker and Barter Exchange Transactions. Two other forms on the list include Form 1099-MISC, Miscellaneous Income, and Form 1099-INT, Interest Income. Which do you think the IRS received more of?
What income tax rate are payers supposed to use for backup withholding?
The IRS identified more than 18.9 million tax year 2013 information returns subject to backup withholding with missing or incorrect taxpayer identification numbers. What percentage of payers associated with these returns did the IRS notify about the errors?
Information returns generally should not be submitted using the social security number of a deceased taxpayer for identification of the payee. However, for tax year 2013, TIGTA identified 2.3 million returns submitted by payers for 1.6 million individuals in which the payee taxpayer identification number was that of a deceased individual who had been dead least two years prior to the issuance of the information return. These 2.3 million returns had reportable payments totaling $4 billion.
TIGTA recommended that the IRS add an indicator to the IRS taxpayer identification number matching program alerting a payer of a payee’s use of a deceased taxpayer social security number.
The IRS initially agreed to this recommendation, then said no. Do you know why the IRS decided not to add an indicator to the matching program?
Note: This information should not be considered legal, investment, or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment, or tax advice. Always consult your legal, investment, and/or tax advisor regarding your personal situation.
For tax year 2013, the IRS received 144,457,943 Forms 1099-INT, and 91,102,779 Forms 1099-MISC.
If backup withholding applies, internal revenue code section 3406 requires payers to backup withhold at a rate of 28% on reportable payments to a payee.
The IRS notified payers associated with 10.8 million (57%) of the identified returns. The remaining 8.1 million were excluded from the payer notification process.
Note that the IRS uses filter criteria to exclude payers of specific information returns containing a missing or incorrect TIN. The filter criteria were established to promote compliance and minimize payer burden.
However, management stated that the criteria used to exclude payers from the notice file were developed many years ago and that they did not know why certain criteria were being used.
The IRS agreed with this recommendation, stating it would first evaluate if a general indicator could be added to the matching program without violating disclosure rules. If such an indicator was legally permissible, then the IRS would evaluate the cost/benefit of programming changes and take the appropriate actions.
After evaluation, the IRS determined that alerting a payer of a payee’s use of a deceased taxpayer social security number is an improper disclosure and violates internal revenue code section 6103.
However, the IRS also recognizes the potential significance of this issue and requested that TIGTA provide the data analysis performed to identify the 2.3 million information returns with a deceased payee taxpayer identification number. The IRS stated that it would review this information to determine how best to address this issue.