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Last Week in Payroll: Backup Withholding

Christopher Wood, CPP  

· 6 minute read

Christopher Wood, CPP  

· 6 minute read

A blog of some of the prior week’s more important federal, state and local payroll stories. This week’s focus is on backup withholding.

Backup Withholding

The IRS requires the payer of certain income payments to be reported on information returns (e.g., Form 1099-NEC, Nonemployee Compensation). Generally, the payer does not withhold taxes from these types of payments, as it is assumed that the payee will report and pay taxes on this income when the federal income tax return is filed.

However, there are situations where the payer is required to withhold at the current rate of 24%. This 24% is taken from any future payments to make sure the IRS receives the tax due on this income and is known as backup withholding (BWH).

The Tax Equity and Fiscal Responsibility Act of 1982 and Interest and Dividend Compliance Act of 1983 requires payers to backup withhold tax from certain reportable payments. BWH’s purpose is to make sure the federal government is able to collect tax on all appropriate income, particularly income not usually subject to withholding.

BWH may be required if the payee failed to provide a correct taxpayer identification number (TIN) to the payer for reporting on the required information return.  A TIN can either be the payee’s Social Security Number (SSN), employer identification number (EIN) or individual taxpayer identification number (ITIN). This is known as the Backup Withholding “B” Program (BWH-B). A payer must begin this withholding at the 24% rate on the payees’ payments.

The IRS will issue a CP2100 or CP2100A Notice if the payee’s name and TIN on the information return filed does not match the IRS’s records. This notice informs the payer of its responsibility to begin backup withholding.

Beginning in tax year 2020, the IRS issued a new Form 1099-NEC for business taxpayers who receive nonemployee. Payers must complete this form to report any payment of $600 or more to a payee. Generally, the due date for Form 1099-NEC is January 31 (next business day if date falls on a weekend/holiday). Nonemployee compensation may be subject to backup withholding if the payee has not provided a TIN to the payer or the IRS has notified the payer that the TIN provided was incorrect.

Employers use Form 945, Annual Return of Withheld Federal Income Tax, to report withheld federal income tax from nonpayroll amounts that include backup withholding, which is reported on line 2. Part N of the instructions for certain information returns provides more information on backup withholding.

A May 17, 2021 Treasury Inspector General for Tax Administration (TIGTA) report explained that backup withholding noncompliance and underreported employment taxes continue to contribute billions of dollars to the tax gap. The IRS’s most recent estimate of the tax gap was $441 billion.  TIGTA issued a prior report on backup withholding issues in 2016.

Now let’s take a look at some of the more important payroll stories from the past week.

Federal News

SAVE Act under review in House. The Savings for All Vocations Enhancement Act (SAVE) of 2021 is currently under review in the House Committees on Ways and Means and Education and Labor. The bill would amend the Internal Revenue Code and Employee Retirement Income Security Act of 1974 to allow multiple employers to provide Section 403(b) plans to employees as if they were a single plan. The proposed changes would not impact plans purchased under a church plan. The bill would also address changes to excise taxes charged on retirement plans. Changes made in the bill would apply to tax years beginning with 2022.

Electronic Tax Committee’s annual report to Congress. The annual Electronic Tax Administration Advisory Committee (ETAAC) report to Congress and the IRS contains 10 recommendations. These recommendations include providing the IRS with flexible, predictable multi-year funding, accelerate the deadline for certain information returns, integrating the Form 1099 Platform with key stakeholders, and increase electronic filing goals. The report shows that the overall e-file rate for all returns combined exceeds the IRS 80% goal, the employment Form 94X series only had a 50.3% e-filing rate for tax year 2020, with a 52.6% e-filing rate estimated for 2021. The report can be viewed in full here.

IRS updates Publication 1281 to include Form 1099-NEC. A May 2021 version of IRS Publication 1281, Backup Withholding for Missing and Incorrect Name/TINs, to reflect the use of Form 1099-NEC for reporting commissions, fees, or other payments for work performed as an independent contractor. Form 1099-NEC took effect for the 2020 tax year.

Draft version of Form 943 and 945. The IRS has issued a draft version of Form 943, Employer’s Annual Federal Tax Return for Agricultural Employees and Form 945, Annual Return of Withheld Federal Income Tax. The draft forms include information related to the COVID-19 tax credits.

Form I-9 receipts guidance updated. There is new guidance from the U.S. Citizenship and Immigration Services (USCIS) on the acceptance of “receipts” in place of documents used to satisfy identification requirements on Form I-9, Employment Eligibility Verification.

State and Local News

Budget bill includes unemployment taxable wage base increase. Arizona legislation will increase the state’s unemployment taxable wage base from $7,000 to $8,000 in 2023.

Unemployment taxable wage base increase. Iowa has announced that the unemployment taxable wage base will increase from $32,400 in 2021 to $34,800 in 2022.

Due date for unemployment taxes extended. Massachusetts has extended the unemployment tax due date for the first quarter of 2021 from April 30, 2021 until July 31, 2021.

Reporting and withholding lump sum payments subject to child support. Nevada legislation addresses lump sum payments made to employees or other income recipients who are subject to a child support withholding order.

Expanded summer work hours for minors. New Jersey legislation has expanded the summer work hours for minors between the ages of 16 and 18 to 50 hours per week with parental permission. The measure will expire on September 6, 2021.

Unemployment tax rates. Vermont has announced that the unemployment tax rates for employers beginning on July 1, 2021 are increasing. Unemployment tax rate schedule III will be in effect from July 1, 2021 through June 30, 2022.  Tax rates range from 0.8% to 6.5%.

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