What is backup withholding?

Backup withholding is a 24% federal tax withholding required on certain payments when the payee fails to provide a correct taxpayer identification number (TIN) or the IRS notifies the payer of a TIN mismatch. For professional service firms paying contractors, backup withholding applies when W-9 forms are missing or contain incorrect information.

Key characteristics

• 24% federal withholding rate

• Applies when TIN is missing or incorrect

• Triggered by the IRS B notice

• Payer must withhold and deposit

• Reported on Form 945

• Payee claims credit on tax return

Why it matters for professional service firms

Backup withholding creates administrative burden and cash flow issues for contractors. Avoiding it requires collecting accurate W-9 forms before payment. Professional service firms should verify contractor information upfront to avoid backup withholding requirements and strained vendor relationships.

Real-world example

David paid the contractor $15,000 without collecting a W-9. IRS rules required 24% backup withholding. Calculation: $15,000 times 24% equals $3,600 withholding. David should have paid the contractor $11,400 and deposited $3,600 with the IRS. Instead, he paid the full amount without withholding, creating potential liability. New process: Collect W-9 before any payment.