Who Is Exempt from Backup Withholding?
Anyone whose annual taxable U.S. income is tabulated exclusively from W-2 forms is automatically exempt from the concept of backup withholding. Only an individual whose income for a taxable year additionally or exclusively involves 1099 forms may be subject to this precautionary or punitive fee.
Different Type of 1099 Forms
Beyond the purview of 1099-G forms, which the federal government issues directly for income such as unemployment insurance, there are 1099 forms for freelance contractor income (MISC), financial deposit interest (INT) and financial transaction income (DIV, B). In all of these cases, the bank or business that has issued the money may also have been ordered to withhold up to 28% that annual income if the taxpayer identification information for the payee is either missing or incorrect, or the payee is delinquent in some way with regards to taxes owed on 1099 income received for previous year.
These delinquencies are defined as either an amount owed for a previous year that is on the record as not having been paid, with interest, or the absence of a signed waiver for a case where the recipient states that they are not liable for the delinquencies as claimed by the IRS.
Put another way, the vast majority of American taxpayers - legal residents and citizens with valid social security numbers - will never have to deal with the matter of backup withholding. But for a small number of illegal aliens, foreign nationals and unscrupulous residents and citizens, who may have not fully declared miscellaneous income for a previous year, the U.S. government safety net of backup withholding is one in which they will suddenly find themselves entangled.
When individuals win money at a U.S. casino, they are issued a W2-G form along with a payout of 75% of the money. However, the accompanying rate of a 25% withholding may be raised to 28% if they refuse to, or cannot, provide a proper taxpayer identification number.