Backup Withholding Under IRC Section 3406: Triggers and Rate

Backup withholding is a flat 24 percent that a payer must take out of certain payments and send straight to the IRS when the person receiving the money hasn’t given a valid Taxpayer Identification Number or has run into other compliance problems under Internal Revenue Code Section 3406. It most often hits independent contractors, bank customers, investors, and gambling winners. The withheld money isn’t a penalty and isn’t lost; it counts as federal income tax already paid on your behalf, and any excess comes back as a refund when you file.1Internal Revenue Service. Backup Withholding

What Triggers Backup Withholding

Section 3406 lists four situations that force a payer to start withholding. Any one of them is enough, and the payer has no discretion once it applies.2Office of the Law Revision Counsel. 26 USC 3406 – Backup Withholding

  • You didn’t give the payer a TIN when asked, or the number you gave is obviously invalid (wrong length, wrong format). For individuals the TIN is usually a Social Security Number; for businesses it’s an Employer Identification Number.
  • The IRS told the payer your name and TIN don’t match its records. The IRS does this through a CP2100 or CP2100A notice, commonly called a B-notice. The payer has to start withholding no later than 30 business days after receiving it.3Internal Revenue Service. Backup Withholding for Missing and Incorrect Name/TINs
  • You underreported interest or dividend income on prior returns. The IRS runs a separate C-notice process for this, and it eventually tells your payers to start withholding.
  • You didn’t certify on Form W-9, under penalty of perjury, that your TIN is correct and that you aren’t already subject to backup withholding.

Once withholding starts, it doesn’t stop on its own. The payer keeps taking out 24 percent until you send a corrected W-9 or the IRS formally tells them to stop.

Which Payments Are Subject

Backup withholding reaches most of the income types reported on 1099 forms, plus certain gambling winnings on Form W-2G:1Internal Revenue Service. Backup Withholding

  • Interest (1099-INT) and dividends (1099-DIV)
  • Non-employee compensation for independent contractors (1099-NEC)
  • Rents, royalties, and other income (1099-MISC)
  • Broker and barter exchange proceeds (1099-B)
  • Payment card and third-party network transactions (1099-K)
  • Attorney’s fees and settlement proceeds (1099-NEC or 1099-MISC)
  • Cash portion of patronage dividends (1099-PATR)
  • Cash payments of original issue discount (1099-OID)
  • Certain government payments (1099-G)
  • Gambling winnings that meet reporting thresholds (W-2G)

For gambling, the reporting and withholding threshold for 2026 is $2,000, and it will be adjusted for inflation after that. Some wagers, like horse racing and sports betting, also require the winnings to be at least 300 times the amount wagered before withholding applies.4Internal Revenue Service. Instructions for Forms W-2G and 5754

The 24 percent rate is flat. It doesn’t care about your bracket, so someone in the 10 percent bracket has too much taken out, and someone in the 37 percent bracket still owes more at filing time. The rate is tied by statute to the fourth-lowest income tax bracket under Section 1(c), which currently sits at 24 percent.2Office of the Law Revision Counsel. 26 USC 3406 – Backup Withholding

Who Doesn’t Have to Worry

Certain payees are treated as exempt and can claim that status by entering the right code on Form W-9. The main exempt categories are corporations, tax-exempt organizations under Section 501(a), government entities at any level, banks and similar financial institutions defined under Section 581, registered securities dealers and futures commission merchants, REITs and registered investment companies, IRAs and certain trust accounts, and foreign governments.5Internal Revenue Service. Instructions for the Requester of Form W-9 A payer can generally rely on the exemption claim unless it has actual knowledge that the claim is wrong.

Individuals and most partnerships are not on that list. If you’re a freelancer, an investor, or a bank customer, you still need to hand over a valid TIN.

Foreign persons sit outside the Section 3406 system entirely. Payments to non-U.S. individuals and entities fall under Chapter 3, which imposes a default 30 percent withholding rate on U.S.-source interest, dividends, and royalties.6eCFR. 26 CFR 1.1441-1 – Requirement for the Deduction and Withholding of Tax on Payments to Foreign Persons A foreign payee documents their status with a Form W-8BEN or another form in the W-8 series rather than a W-9, and a tax treaty may reduce or eliminate the 30 percent rate if the paperwork is filed correctly.7Internal Revenue Service. About Form W-8 BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting

How to Stop or Prevent It

Give the Payer a Correct Form W-9

The simplest fix is to fill out Form W-9 accurately the first time. The form asks for your legal name, your TIN, and a signed certification, under penalty of perjury, that the information is right and you’re not currently subject to backup withholding.8Internal Revenue Service. About Form W-9, Request for Taxpayer Identification Number and Certification Most payers send it during onboarding, and it’s available on the IRS website if you need a fresh copy.

Respond to a B-Notice

If withholding has already started because of a name/TIN mismatch, what you need to do depends on whether it’s your first or second B-notice from that payer.9Internal Revenue Service. Backup Withholding “B” Program

On a first B-notice, the payer sends you a copy of the IRS notice and a blank Form W-9. Return a properly completed and signed W-9 with the right TIN and withholding stops. If your name and TIN show up mismatched again within three years, the second B-notice asks for more. A new W-9 isn’t enough. You have to provide either a copy of your Social Security card or an IRS Letter 147C verifying the name and EIN match.

Fix a C-Notice by Correcting Your Returns

C-notice withholding is triggered by underreported interest or dividend income, and the IRS moves slowly before getting your payers involved. It sends the taxpayer at least four notices over a period of at least 120 days to correct the return first. Only after those go unanswered does the IRS contact payers and direct them to withhold 24 percent from future interest and dividend payments.10Internal Revenue Service. Backup Withholding “C” Program

To turn off C-notice withholding, file the missing returns or amend the incorrect ones so the reported amounts match reality. That’s the whole process. You don’t need to separately contact the IRS to tell them you’ve fixed it, and a new W-9 won’t help here.

Getting the Money Back at Tax Time

Backup withholding is not a penalty. It’s a prepayment of your federal income tax, and it gets treated the same as payroll withholding on a W-2. When you file Form 1040, the 1099s from your payers will show both the total income and the amount withheld, and you report that withheld amount in the federal income tax withheld section of the return. If the 24 percent that came out is more than you actually owe, the excess comes back as a refund. For lower-bracket taxpayers that overpayment is common, because the flat rate is set well above their marginal rate.

Penalties for Trying to Dodge It

Claiming you’re not subject to backup withholding when you actually are carries real consequences. On the civil side, a false statement that reduces your withholding brings a $500 penalty per statement, and there’s no reasonable-basis defense once the statement is made.11Office of the Law Revision Counsel. 26 USC 6682 – False Information With Respect to Withholding

Willfully filing a false certification to avoid backup withholding is a criminal offense under Section 7205(b), punishable by a fine of up to $1,000, up to one year in prison, or both.12Office of the Law Revision Counsel. 26 USC 7205 – Fraudulent Withholding Exemption Certificate or Failure to Supply Information If the false certification produced financial gain or caused loss to someone else, general federal sentencing rules can push the fine up to twice the gross gain or twice the gross loss.

On the payer’s side, failing to withhold when required doesn’t shift the tax back to the payee. The payer becomes personally liable for the 24 percent that should have come out, which is why most payers push hard on getting W-9s right at onboarding rather than letting the paperwork slide.