The simplest way to think of backup withholding is to see it as a safety net used by the federal government when dealing with certain recipients of income that is not a wage, salary or tips.
How Backup withholding Is Tracked
This type of income is tracked annually by banks and business through the use of four main kinds of 1099 forms. A 1099-MISC reports independent contractor income; a 1099-INT covers interest income; a 1099-DIV tabulates dividends and capital gains earned from stocks and bonds; and a 1099-B covers income generated from securities transactions. All 1099 forms for a tax year must be sent out to recipients by no later than January 31st of the following year.
When to Withhold
There are also four general scenarios for which the Internal Revenue Service (IRS) dictates that an upfront, backup withholding must be applied to 1099 form income. Two are of a straightforward bookkeeping nature (the recipient’s tax identification number is missing or incorrect), while two others relate to a more egregious scenario (the recipient failed to properly report 1099 income for a previous tax year, or failed to certify that they were not liable for prior year delinquencies).
Another common scenario for backup withholding is at the casinos of Las Vegas, Atlantic City and beyond. If a winning foreign national or U.S. permanent resident does not provide the casino with a social security number, a higher backup withholding will be applied on the W2-G form. That rate is a 28% rather than the standard 25%, covering $600 or more of certain types of gambling winnings, $1,200 or more in bingo or slot machine winnings, $1,500 or more in keno monies and $5,000 in poker winnings.
H&R Block – Different Types of 1099 Forms, Retrieved August 28, 2010 from http://hrblock.com/taxes/tax_tips/tax_planning/reading_1099.html
Internal Revenue Service – Topic 307: Backup Withholding, Retrieved August 28, 2010 from http://www.irs.gov/taxtopics/tc307.html
Internal Revenue Service – Backup Withholding for Incorrect Name/Tin(s), Retrieved August 28, 2010 from http://www.irs.gov/pub/irs-pdf/p1281.pdf