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Taxes for Individuals Who are Not U.s. Citizens

  1. Expatriate
  2. Tax Treaty
  3. IRS Publication 519
  4. Worldwide Income
  5. Backup Withholding
  6. Nonresident Alien
  7. Non-Resident

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Backup Withholding: Definition & Who has to Pay?

Updated: November 25, 2022

As an investor or an analyst, there are going to be a ton of moving parts to consider. You want to conduct proper due diligence to ensure future investments provide a positive return. But once you make an investment, there are a whole set of new considerations to take into account. 

Do you need to pay taxes on gains or losses? What if you withdraw your investment early, are there any implications to this? These are all good questions to ask. Backup withholding is a tax rate that you should be aware of. Read on to learn what you need to know about backup withholding, including how it works and much more!

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    KEY TAKEAWAYS

    • Funds reserved for taxation purposes for withdrawn investment income are known as backup withholding.
    • The IRS uses backup withholding to ensure that it receives taxes. This is on earnings that a taxpayer may have already spent prior to the filing deadline.
    • A taxpayer may provide an invalid taxpayer identification number (TIN) or fail to disclose certain categories of income. In this case, a backup withholding at a rate of 24% may be levied.
    • Interest payments, dividends, and rent are some of the payments that are susceptible to backup withholding.
    • Compensation for unemployment and retirement benefits are not subject to backup withholding.

    What Is Backup Withholding?

    Backup withholding is a fee assessed at a predetermined tax rate. This is on investment profits as the investor withdraws it. Payers are obligated to withhold tax from payments that are not subject to withholding. Backup withholding makes it possible for tax-collecting authorities like the Internal Revenue Service (IRS) or the Canada Revenue Agency to obtain the income taxes that are due from investment revenues.

    When an investor does not adhere to the requirements surrounding taxpayer-identification numbers (TIN), backup withholding may be used. The amount required under the backup withholding tax is transmitted to the government. This is when the investor withdraws their investment income. This gives the tax-collecting body the necessary sums right away. But it also reduces the investor’s short-term cash flow.

    Turn Tax Pains Into Tax Gains

    When Is Backup Withholding Required?

    The majority of taxpayers are not subject to backup withholding. As long as they accurately provide their names, Social Security numbers, or TINs, to the payer and that information matches IRS data, U.S. citizens and resident aliens are exempt.

    They are also exempt if the IRS has informed them that, for some reason, they are not subject to obligatory backup withholding.

    Credit for Backup Withholding

    Report the federal income tax withholding (reported on Form 1099 or W-2G) for the year you received the income. This is if it was withheld under the backup withholding rule.

    Real estate transactions, payouts from retirement accounts, and unemployment benefits are among the payments that are exempt from the requirement of withholding.

    Payments Subject to Backup Withholding

    The following typical payment forms could be subject to backup withholding for people who are not exempt:

    • Interest
    • Dividend income
    • Governmental payments
    • Rents
    • Royalties
    • Commissions
    • Gambling winnings
    • Patronage
    • Broker commissions on stock transactions
    • Payments from owners of fishing boats
    It's Time For Owners To Own Tax Season

    Payments Excluded From Backup Withholding

    Payments exempt from backup withholding include:

    • Property transactions
    • Repossessions and abandonments
    • Debt cancellations
    • Archer MSA distributions
    • Long-term care advantages
    • Withdrawals from any type of retirement account
    • Payments made under an employee stock ownership plan
    • Payment to fishing operators with cash
    • Unemployment benefits
    • Reimbursements of local or state income taxes
    • Earnings from approved tuition programs

    How to Prevent or Stop Backup Withholding

    You must address the issue that led to your becoming subject to backup withholding in order to stop it. This may entail giving the payer the right TIN, solving the underreported types of income, and paying the debt. Or, if necessary, submitting the necessary return or returns.

    Summary

    The IRS uses backup withholding, which entails payers withholding a percentage of their payments to the taxpayer, to make sure that all taxes owed on specific categories of income are paid when they haven’t been properly reported in the past.

    It only applies to situations in which there is no customary requirement for federal tax withholding, such as 1099 income or winnings from gaming.

    Save 40 Hours During Tax Season

    FAQS on Backup Withholding

    Is Backup Withholding a Bad Thing?

    Backup withholding is undesirable, yes. Nevertheless, it can be fixed by either giving the necessary tax information, including the right taxpayer identification number, by filing the requisite tax forms or by paying the outstanding balance.

    Can Backup Withholding Be Refunded?

    Your backup withholding tax can be repaid, just like any overpayment. Your Form 1099 will note any federal income tax withheld from your pay as such. When you submit your federal return at the end of the tax year, this is then reported as taxes withheld. You’ll get a refund if you overpaid.

    Who Pays Backup Withholding?

    These taxes on payments must be withheld by business owners or payers. When a firm receives notification from the IRS that backup withholding is necessary, the payer is required to deduct the flat amount of 24% from the payee’s income.

    Do You Get Back Tax Withheld?

    The amount collected is applied as a credit to the employee’s yearly income tax liability. If too much money is withheld, the employee gets a tax refund; if not enough, the employee might have to pay the IRS.

    Taxes for Individuals Who are Not U.s. Citizens

    1. Expatriate
    2. Tax Treaty
    3. IRS Publication 519
    4. Worldwide Income
    5. Backup Withholding
    6. Nonresident Alien
    7. Non-Resident

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