If federal tax is being withheld from your savings account interest, your bank has placed your account under backup withholding, which takes a flat 24% of each interest payment and sends it to the IRS.1Internal Revenue Service. Backup Withholding Banks do not normally withhold anything from savings interest, so if you are seeing a deduction, something on your account has triggered this rule, and it will keep happening on every interest payment until the underlying problem is resolved.
Backup Withholding Is the Only Reason a Bank Withholds
Interest from a savings account, money market account, or CD is taxable, but the bank ordinarily pays it to you in full and leaves the tax to you.2Internal Revenue Service. Topic No. 403, Interest Received Backup withholding is the single exception. When it applies, the bank deducts 24% from your interest before crediting the rest to your account and remits that 24% to the IRS.3Internal Revenue Service. Topic No. 307, Backup Withholding It is not a penalty, and it is not based on your tax bracket. It is a flat collection mechanism the IRS uses when it cannot otherwise be sure the tax on your interest will get paid.
What Triggered It on Your Account
Federal law lists four situations that require a bank to begin backup withholding, and every one of them traces back to your taxpayer identification number (TIN), which for most individuals is a Social Security number.4Office of the Law Revision Counsel. 26 USC 3406 – Backup Withholding Figuring out which one applies to you is the first step toward making it stop.
You Never Gave the Bank a TIN
When you open an account, the bank asks for your Social Security number on a Form W-9.5Internal Revenue Service. About Form W-9, Request for Taxpayer Identification Number and Certification If no number was ever provided, or the one on file is incomplete, the bank has to begin withholding at once.6Internal Revenue Service. Backup Withholding B Program This is the most common trigger and the easiest to clear.
The IRS Told the Bank Your TIN Does Not Match
If the number you gave the bank does not match IRS records when the 1099-INT is filed, the IRS sends the bank a CP2100 or CP2100A notice, and the bank sends you a “B-Notice.” The first B-Notice comes with a blank W-9 to correct the number. A second B-Notice within three years requires stronger proof, meaning a copy of your Social Security card or an IRS Letter 147C.8Internal Revenue Service. Backup Withholding B Program
You Gave a TIN but Did Not Sign the Certification
The W-9 asks you to certify, under penalty of perjury, that your number is correct and that you are not currently subject to backup withholding. Supplying the number without signing is not enough, and the bank can withhold on that basis alone.7Office of the Law Revision Counsel. 26 USC 3406 – Backup Withholding
The IRS Found You Underreported Interest or Dividends
The IRS can also order backup withholding if it determines you underreported interest or dividend income on a prior return. Under this program, the IRS notifies both you and your bank directly.1Internal Revenue Service. Backup Withholding This is the hardest trigger to clear, because the bank cannot lift the withholding until the IRS tells it to.
How to Make It Stop
The remedy depends on which trigger you are dealing with. In every case the bank is waiting on something before it can turn the withholding off.
Missing TIN or missing signature. Submit a properly completed and signed Form W-9 to your bank. Withholding stops once the bank processes it, and the statute allows up to 30 additional days for the change to flow through the bank’s payment system.4Office of the Law Revision Counsel. 26 USC 3406 – Backup Withholding
B-Notice from the bank. Send back exactly what the notice asks for. A First B-Notice is satisfied by a corrected W-9. A Second B-Notice requires a copy of your Social Security card or an IRS Letter 147C confirming your name and number match.6Internal Revenue Service. Backup Withholding B Program Ignoring a B-Notice is what starts the withholding in the first place, and the second round is harder to clear than the first.
IRS determination of underreporting. You have to deal directly with the IRS, not your bank. You can pay the assessed tax, show that no underreporting occurred, correct the error on an amended return, or demonstrate that continued withholding would create an undue hardship and that you are unlikely to underreport again.9eCFR. 26 CFR 35a.3406-2 – Imposition of Backup Withholding for Notified Payee Underreporting If the IRS rules in your favor, it issues a written certification to you and notifies your bank to stop. Until that notification arrives, the bank must keep withholding.
You Get the Money Back at Tax Time
The 24% that gets pulled out is not gone. It functions like the federal tax your employer withholds from a paycheck: a prepayment credited against your annual tax bill. Your bank reports the total interest you earned and the amount withheld on Form 1099-INT, with the withheld figure in Box 4.10Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID When you file, you claim it as federal income tax already paid, which either reduces what you owe or increases your refund.3Internal Revenue Service. Topic No. 307, Backup Withholding
Because 24% is a flat rate, it rarely matches your actual tax on that interest. Someone in the 12% bracket with $5,000 of interest subject to backup withholding would have $1,200 held back but owe only about $600 in tax on it, so the other $600 comes back as a refund. In the 32% or 35% bracket, the 24% withheld will not cover the full liability on that interest, and you will owe the difference.
Why Nothing Was Withheld Before (and What You Still Owe)
For most account holders, backup withholding never applies, and the interest arrives untouched. That does not mean the interest is tax-free. Your bank reports it to the IRS on Form 1099-INT whenever you earn $10 or more in a year, and even smaller amounts have to go on your return.2Internal Revenue Service. Topic No. 403, Interest Received Interest is taxed at your ordinary income rate, so $1,000 in savings interest costs roughly $220 in federal tax for someone in the 22% bracket.
Because nothing is withheld along the way, you are the one responsible for making sure enough tax is paid during the year. If you expect to owe $1,000 or more after your other withholding and credits, the IRS generally wants quarterly estimated payments.11Internal Revenue Service. Form 1040-ES, Estimated Tax for Individuals You can avoid an underpayment penalty by paying at least 90% of this year’s tax or 100% of last year’s (110% if your AGI exceeded $150,000).12Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty If you have a regular paycheck, a simpler option is to raise the withholding on your Form W-4 so the extra tax comes out of wages instead.13Internal Revenue Service. Tax Withholding Either way, the obligation is the same: the bank is not withholding for a reason, and the tax still has to be paid.