At some point in the life of a business owner, you will probably bring in contract workers to assist you in serving your customers and clients. While the paperwork for these contractors is much simpler than for a regular employee, there are some steps you need to take to make sure you are in compliance with the law and tax codes.
All contractors must fill out and submit to you a completed W-9 that contains their Taxpayer Identification Number (TIN), which in some cases will be a Social Security Number (SSN). You will use this to report to the IRS on Form 1096 and to the contractor on Form 1099-MISC how much money you paid them during the tax year.
But what happens if they don’t give you a W-9, despite repeated requests? The contractor will be subject to backup withholding, and you will have to withhold a portion of their payments.
What Is Backup Withholding?
If you are an employee, your employer has you fill out numerous forms to be sent to the IRS that let the agency know that you are employed at the company and that it will be withholding money from your paycheck to cover taxes, which will be sent to the IRS.
If you are a contractor, nothing is withheld from the amount your client pays you, as it is assumed you will pay these taxes when you file your tax return. If you don’t provide clients with a W-9 that has an accurate TIN, they have no way to report the amounts paid to you and on which you owe taxes. When this happens, the IRS requires your client to withhold 28% of any payment to you to make sure that the IRS receives any taxes due from you. This is called “backup withholding.”
Keep in mind that if the contractor has indicated on the W-9 that they are exempt from backup withholding, you do not need to withhold anything.
As a business owner who hires contractors, you will need to withhold from any payments you make to the contractor 28% of the amount due in the following circumstances:
- You do not receive a W-9 from the contractor with the TIN.
- You receive a notice from the IRS that the TIN provided by the contractor is incorrect.
- If you pay out interest or dividends, you receive a notice from the IRS that you need to start withholding on interest or dividends because a contractor has underreported interest or dividends.
How to Handle Backup Withholding
Once you start withholding 28% of the amount due to the contractor, you will need to record this in your accounting records as a liability, as it is an amount you owe the IRS. At the end of the year, you will need to complete IRS Form 945, Annual Return of Withheld Federal Income Tax, and send that along with a payment for the amounts withheld to the IRS by February 1 of the following year.
If you receive a letter from the IRS stating that the TIN you listed when you filed your Form 1096 is incorrect, check your records to ensure that you provided the IRS with the number the contractor provided to you. If there was no mistake on your end, you will need to send what is called a “B” notice to the contractor. This is a notice that tells the contractor that the TIN they provided you is incorrect, and they need to furnish you the correct TIN. You will need to send this form within 15 days of the notice from the IRS. There is no IRS form to use for this, so you will need to write a letter to the contractor telling them what happened and that you need a correct TIN.
Additionally, you will need to start withholding the backup withholding within 30 days of receiving the notice from the IRS about the incorrect TIN. If the contractor sends you the required information within 30 days, stop backup withholding immediately.
For more in-depth guidance on managing taxes when you hire contractors, see our guide to 1099s for business owners.