If taxpayers fail to provide their bank with a taxpayer identification number, they are subject to backup withholding on interest payments. True False
The correct answer and explanation is:
Correct Answer: True
If taxpayers fail to provide their bank with a valid Taxpayer Identification Number (TIN) — usually a Social Security Number (SSN) or Employer Identification Number (EIN) — they are subject to backup withholding on interest payments and certain other types of income.
Explanation:
Backup withholding is a method the Internal Revenue Service (IRS) uses to ensure it receives taxes owed on certain types of income. Normally, income such as bank interest, dividends, and other financial earnings is reported to the IRS, but no tax is withheld at the time the income is paid. However, when a taxpayer does not furnish the correct TIN or fails to certify that they are not subject to backup withholding, the IRS requires the payer (such as a bank) to withhold tax — currently 24% — from those payments.
This rule is outlined in Internal Revenue Code (IRC) Section 3406. If a bank or financial institution does not receive a valid TIN on Form W-9, or if the IRS notifies the bank that the TIN is incorrect or missing, the institution is required by law to begin backup withholding.
Backup withholding can apply to:
- Interest payments
- Dividends
- Broker and barter exchange transactions
- Rents, royalties, and other fixed or determinable income
- Certain payments from fishing boat operators
- Payment card and third-party network transactions
Failing to provide a TIN can not only result in withheld funds but may also lead to penalties and issues when filing income tax returns, as the withheld amounts must be reported and claimed on the tax return.
To avoid backup withholding, taxpayers should ensure they provide accurate and complete tax information to any institution paying them reportable income.