Understanding Backup Withholding On Life Insurance: Your Responsibilities

Backup withholding is a tax levied on investment income at a rate of 24% (or 30% for non-resident foreign persons) that is automatically deducted from certain non-payroll income when a taxpayer has failed to provide the necessary information. This includes failing to provide a correct taxpayer identification number (TIN) or not reporting certain types of income, such as interest, dividends, or rents. Life insurance policies are not specifically mentioned in the context of backup withholding. However, it is important to note that different rules and rates may apply to US persons and foreign persons when it comes to backup withholding. To determine if you are responsible for backup withholding on life insurance, it is advisable to consult official sources, such as the Internal Revenue Service (IRS) or a tax professional.

What is backup withholding?

Backup withholding is a type of federal income tax in the US. It is a tax levied on investment income at a rate of 24% (for US citizens and resident aliens) or 30% (for non-resident foreign persons). It is important to note that this tax is only applied to payments that are not otherwise subject to tax withholding.

Backup withholding is typically applied in two scenarios:

• Backup Withholding "B" Program: This applies when a taxpayer fails to provide a correct Taxpayer Identification Number (TIN) to the payer. A TIN can be a Social Security Number (SSN), an Employer Identification Number (EIN), or an Individual Taxpayer Identification Number (ITIN).
• Backup Withholding "C" Program: This applies when a taxpayer fails to report or underreports interest and dividend income on their federal income tax return, or fails to certify that they are not subject to backup withholding due to previous underreporting of income.

Backup withholding helps ensure that government tax-collecting agencies, such as the Internal Revenue Service (IRS), receive the income taxes owed to them. It is a way to collect taxes on income that an investor may have already spent before their tax bill is due, preventing potential tax shortfalls.

To stop or avoid backup withholding, taxpayers need to correct the issue that led to it. This could include providing the correct TIN, resolving underreported income, or filing missing returns.

When is backup withholding applied?

Backup withholding is a tax levied on investment income at a rate of 24% for US citizens and resident aliens, and 30% or an IRS-specified lower percentage for non-resident foreign persons. It is applied when:

• A taxpayer identification number (TIN) is not provided to the payer. This can include a Social Security number (SSN), an employer identification number (EIN), or an individual taxpayer identification number (ITIN).
• The TIN provided to the payer is incorrect.
• The taxpayer has not reported or has underreported interest and dividend income on their federal income tax return.
• The taxpayer has failed to certify that they are not subject to backup withholding for underreporting interest and dividends.

In the case of an incorrect or missing TIN, the payer will notify the taxpayer and request the correct information. If the issue is not resolved, backup withholding may begin immediately. For underreported income, the IRS will send up to four notices over a 120-day period before instituting backup withholding.

Who is responsible for backup withholding?

Backup withholding is a type of federal income tax that is deducted by payers when their 1099 or W-2G payee has failed to provide a valid TIN number or show that they are exempt from backup withholding. The Internal Revenue Service (IRS) requires the payer of certain types of income payments to report them on an information return. The person or business paying you doesn’t generally withhold taxes from these types of payments, as it is assumed you will report and pay taxes on this income when you file your federal income tax return.

Backup withholding may be required under the BWH-B program because you failed to provide a correct taxpayer identification number (TIN) to the payer for reporting on the required information return. A TIN can be either your social security number (SSN), employer identification number (EIN), or individual taxpayer identification number (ITIN).

Backup withholding may also be required under the BWH-C program because you failed to report or underreported interest and dividend income you received on your federal income tax return; or you failed to certify that you're not subject to BWH for underreporting of interest and dividends.

To stop backup withholding, you'll need to correct the reason you became subject to it in the first place. This can include providing the correct TIN to the payer, resolving the underreported income and paying the amount owed, or filing the missing return(s), as appropriate.

If you are a foreign citizen, or are an American who has not provided your correct TIN/SSN, made the proper certifications, or reported all your taxable interest and dividends on your tax return to the IRS, you may be subject to backup withholding.

How to prevent or stop backup withholding?

To prevent or stop backup withholding, you must correct the reason you became subject to it in the first place. This can include:

• Providing the correct Taxpayer Identification Number (TIN) to the payer. A TIN can be your Social Security Number (SSN), Employer Identification Number (EIN), or Individual Taxpayer Identification Number (ITIN).
• Resolving any underreported income, paying the amount owed, and filing any missing returns.
• Certifying that you are not subject to backup withholding due to previous underreporting of interest or dividends.

If you receive a notice from a payer notifying you that the TIN you gave is incorrect, you can usually prevent backup withholding from starting by giving the payer your correct name and TIN and certifying that the TIN is correct. If you receive a second notice from the payer, you will need to provide verification of your correct name and TIN. Refer to Publication 1281, Backup Withholding for Missing and Incorrect Name/TIN(s) for more details.

How does backup withholding work with life insurance?

Backup withholding is a type of federal income tax that is deducted by payers when their 1099 or W-2G payee has failed to provide a valid Taxpayer Identification Number (TIN) or show that they are exempt from backup withholding. This can include situations where the taxpayer has failed to report or underreported interest and dividend income on their federal income tax return, or accidentally marked themselves as subject to backup withholding.

Backup withholding is calculated at a rate of 24% for US citizens and resident aliens, and 30% or an IRS-specified lower percentage for non-resident foreign persons, depending on the types of income. This tax is taken from any future payments to ensure that the Internal Revenue Service (IRS) receives the tax due on this income.

Life insurance companies are required to withhold taxes on payments they make if the recipient has not provided a correct TIN. This includes situations where the recipient has failed to provide a TIN, provided an incorrect TIN, or failed to report income that is subject to backup withholding. In such cases, the life insurance company must withhold 24% of the payment and remit it to the IRS.

To avoid backup withholding on life insurance payments, individuals must ensure that they provide the correct TIN to the payer and report all taxable income. If backup withholding has already been implemented, it can be stopped by correcting the issue that led to it, such as providing an incorrect TIN or underreporting income.

Frequently asked questions