Independent Contractor Tax and Backup Withholding: 24% Rate and W-9

Businesses generally do not withhold federal income tax from payments to independent contractors, so backup withholding on independent contractor payments is the exception, not the rule. When it applies, the business must deduct a flat 24% of the gross payment and send it directly to the IRS.¹ The rule sits in Internal Revenue Code Section 3406, and it exists to force compliance when a contractor hasn’t provided proper identification or the IRS has flagged their account.²

What Triggers the 24% Withholding

Four situations put a contractor into backup withholding. Each has its own paperwork trail, but the effect on the payment is the same: 24% off the top of every check going forward.

Missing or incomplete TIN. If a contractor never provides a taxpayer identification number, or refuses to submit a Form W-9, backup withholding begins immediately with the first payment.

Incorrect TIN, known as a “B” notice. The IRS sends the business a CP2100 or CP2100A notice when the contractor’s name and TIN combination doesn’t match federal records. The business must then send a “B” notice to the contractor and begin withholding if the mismatch isn’t corrected.³

Underreported income, known as a “C” notice. The IRS contacts the payee directly when they’ve underreported interest or dividend income. If the payee doesn’t fix the problem within a 120-day notice period, the IRS instructs payers to begin withholding on future interest and dividend payments.⁴ The C notice path applies specifically to interest and dividend income rather than payments for services, but a contractor who receives investment income through a business account can still be affected, and any active C notice will show up on their W-9 certification.

Failed certification. When a contractor signs a W-9 but doesn’t certify they’re exempt from backup withholding, or the IRS has notified the contractor they’re no longer exempt, the payer must withhold.

The 24% rate is flat. It doesn’t shift with the contractor’s bracket, filing status, or deductions, and it comes off the gross before any expenses or fees. That can overshoot or undershoot the contractor’s actual tax bill. Either way, contractors claim credit for the withheld amounts on their annual return, and any excess comes back as a refund through normal filing.

How to Stop Backup Withholding Once It Starts

How you get out of backup withholding depends on what got you into it.

Fixing a B Notice

After a first “B” notice, the contractor fixes the problem by giving the payer a properly completed and signed Form W-9 with the correct TIN. If the same contractor shows up on a second CP2100 or CP2100A within three years, a W-9 alone isn’t enough. The contractor must provide a copy of their Social Security card or an IRS Letter 147C verifying the correct name-and-number combination.³

Clearing a C Notice

Stopping withholding triggered by underreported interest or dividend income is harder. Only the IRS can lift it, and the payee has to request a formal determination.⁵ The IRS will stop withholding if the payee shows one of the following:

No underreporting actually occurred, backed by receipts or documentation that all income was properly reported or that the IRS determination rested on a clerical error.
The underreporting has been corrected, with an amended return filed and all taxes, penalties, and interest paid.
Continued withholding causes genuine financial hardship and future underreporting is unlikely.
A good-faith dispute exists over whether any underreporting happened at all.

Once the IRS issues a written determination, withholding stops within 30 days of the payer receiving notification.

Payees and Payments That Are Exempt

Not every payee is subject to backup withholding. Certain entities are exempt because the IRS already tracks their income through other means, and they indicate exempt status on Form W-9 using a specific payee code. Exempt payees include corporations, tax-exempt organizations under Section 501(a), government entities (federal, state, local, and foreign), real estate investment trusts, registered securities dealers, and financial institutions.⁶ Payers can rely on the exemption claim unless they have actual knowledge it’s invalid.

Certain payment types are also excluded regardless of who receives them: real estate transactions, retirement account distributions, cancelled debt, unemployment compensation, state or local income tax refunds, qualified tuition program earnings, and foreclosures and abandonments.¹ These categories have their own withholding rules or reporting mechanisms.

Collecting Form W-9 Before the First Payment

Form W-9 is how a business collects identifying information from a U.S.-based contractor before any money changes hands.⁷ The contractor provides legal name, permanent address, entity type, and TIN (usually a Social Security Number for individuals or an EIN for business entities). In Part II, the contractor signs under penalty of perjury certifying the TIN is correct and that they aren’t subject to backup withholding.

Collect the W-9 before issuing the first payment, and keep the forms for at least four years after the related tax is due or paid, whichever is later.⁸ During an audit, a properly completed W-9 is the proof that you collected the contractor’s information and had no reason to withhold. A missing or incomplete W-9 is one of the fastest ways to end up on the wrong side of a compliance review.

Foreign contractors are outside this system entirely. They cannot submit a W-9. Instead, they provide the appropriate Form W-8 (such as W-8BEN for individuals or W-8BEN-E for entities) or Form 8233 for personal services. If a foreign contractor fails to provide proper documentation, the default withholding rate under Chapter 3 or Chapter 4 (FATCA) is 30%, not the 24% backup rate that applies to U.S. persons.⁶ Confusing the two regimes is a common and expensive mistake.

Depositing and Reporting the Withheld Amounts

Once a business deducts the 24%, those funds have to move to the IRS on a schedule. The money goes through the Electronic Federal Tax Payment System (EFTPS).⁹ Deposit frequency depends on total nonpayroll tax liability during a lookback period:

Monthly depositors send withheld amounts by the 15th of the month following the payment.
Semiweekly depositors deposit within three business days after the close of the semiweekly period.

Annual reporting happens on Form 945, Annual Return of Withheld Federal Income Tax. This form covers only nonpayroll withholding and is separate from Forms 941 or 943 used for employee payroll taxes.¹⁰ Form 945 is due January 31 of the following year, with the deadline shifting to the next business day if it falls on a weekend or holiday. The IRS cross-references EFTPS deposits against Form 945 and each contractor’s 1099-NEC, and any mismatch generates follow-up notices.¹¹

The withheld amounts still show up on the contractor’s 1099-NEC in the federal income tax withheld box, and for 2026 the 1099-NEC filing threshold is $2,000 in nonemployee compensation, raised from $600 by the One Big Beautiful Bill Act.¹²

Penalties for Getting It Wrong

The penalty structure hits from several directions.

Late Deposits

Missed deposit deadlines trigger graduated penalties on the unpaid amount:

1 to 5 days late: 2%
6 to 15 days late: 5%
More than 15 days late: 10%
More than 10 days after an IRS demand notice: 15%

The percentages don’t stack. A deposit 20 days late incurs a 10% penalty, not 2% plus 5% plus 10%.¹³

Trust Fund Recovery Penalty

When a business was required to withhold and willfully failed to collect, account for, or pay over the tax, the IRS can assess the trust fund recovery penalty under 26 U.S.C. § 6672. The penalty equals 100% of the tax that should have been withheld.¹⁴ It’s personal. It attaches to any individual within the business (owners, officers, bookkeepers) with authority and responsibility to collect and remit. The IRS must give written notice at least 60 days before assessing, and if multiple people are liable, anyone who pays can seek contribution from the others.

Information Return Penalties

Filing a 1099-NEC with an incorrect TIN, or failing to file one at all, carries its own 2026 penalty schedule:

Up to 30 days late: $60 per return
31 days late through August 1: $130 per return
After August 1 or not filed: $340 per return
Intentional disregard: $680 per return

Across dozens of contractors, these per-return amounts compound fast.¹⁵

1
Internal Revenue Service. Backup Withholding
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Office of the Law Revision Counsel. 26 USC 3406 – Backup Withholding
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Internal Revenue Service. Backup Withholding “B” Program
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Internal Revenue Service. Backup Withholding “C” Program
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eCFR. 26 CFR 31.3406(c)-1 – Notified Payee Underreporting of Reportable Interest or Dividend Payments
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Internal Revenue Service. Instructions for the Requester of Form W-9
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Internal Revenue Service. About Form W-9, Request for Taxpayer Identification Number and Certification
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Internal Revenue Service. How Long Should I Keep Records
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Bureau of the Fiscal Service. Electronic Federal Tax Payment System
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Internal Revenue Service. Instructions for Form 945
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Internal Revenue Service. Notice 931 – Deposit Requirements for Employment Taxes
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Congress.gov. Tax Provisions in H.R. 1, the One Big Beautiful Bill Act
13
Internal Revenue Service. Failure to Deposit Penalty
14
Office of the Law Revision Counsel. 26 USC 6672 – Failure to Collect and Pay Over Tax, or Attempt to Evade or Defeat Tax
15
Internal Revenue Service. Information Return Penalties