Introduction: Backup Withholding on Interest-Bearing Accounts

This section will tell you what the backup-withholding regulations require you to do on an ongoing basis, after account opening. We dealt with your account-opening duties in Part I. Here we will deal with such things as annual mailings to account holders who have not supplied you with a certified taxpayer identification number (TIN), your obligations in handling the TIN that an account holder supplies, what you need to do if you receive a notice from the IRS saying that an account holder has underreported interest income or has supplied you with an incorrect TIN, how to implement backup withholding when it is required, and what to do after an account holder has given you an “awaiting-TIN” certification.

We deal with many other topics in this section, and we set all the topics out with separate headings for easy reference. No logical order for discussing all these topics exists, so if you are interested in a particular one, check the table of contents at the beginning of this section.

Readers who are new to backup withholding might want to read the introduction to our earlier section on account-opening responsibilities. That introduction discusses, in general terms, what backup withholding is and what its objectives are.

If you are generally familiar with backup withholding and its objectives, you are ready for this section. There are, however, a few terms that you need to understand before you start. The first two are “pre-1984” accounts and “post-1983” accounts. We mentioned these in the backup withholding section in Part I, but they are worth mentioning again because your responsibilities with respect to a particular account vary significantly depending on the category in which the account falls. A “pre-1984” account is one that was in existence before January 1, 1984. [26 CFR 31.3406(d)-1(b)(2)(i)] A “post-1983” account is any other account. An automatically renewable time deposit originally established before January 1, 1984, which has renewed after December 31, 1983, can be considered either a pre-1984 Until that automatic renewal, the account is a pre-1984 account. [26 CFR 31.3406(d)-1(b) (2)(ii)]

The term “payor” means you, or the person making a reportable interest payment. The term “payee” means the account holder, or the person receiving the reportable interest payment. The term “TIN” is an acronym for “taxpayer identification number,” which, for individuals, is a social security number, and for all other entities is an employer identification number.

The term ”due diligence“ is a term which, prior to 1990, broadly described all of the payor’s responsibilities in making sure that the TIN the payor put on a 1099 form was the payee’s correct TIN. [The 1099 is the form payors use to report to the Internal Revenue Service (IRS) the amount of interest paid to a particular payee.] The Internal Revenue Code, prior to 1990, imposed a penalty of $50 per 1099 on payors who filed 1099 forms with incorrect or missing TINs unless the payor had exercised “due diligence” in furnishing the correct TIN. Many different responsibilities were encompassed by the term ”due diligence“— some were account-opening responsibilities and were discussed in Part I; others were ongoing responsibilities and will be discussed in this section.

The Omnibus Budget Reconciliation Act of 1989 (OBRA 1989, P.L. 101-239, Sec. 7711) deleted the “due diligence” standard from the tax code, effective January 1, 1990. OBRA replaced due diligence with what is called the “reasonable cause” standard—a rule which penalizes a payor for failing to include the payee’s correct TIN on Form 1099 unless the failure was due to “…reasonable cause and not to willful neglect.” In December of 1991, the IRS issued final regulations defining the “reasonable cause” standard. Like meeting the due diligence standard, meeting the reasonable cause standard involves many particular responsibilities. Some are account-opening responsibilities and were discussed in Part I. Others are ongoing responsibilities and will be discussed in this section.

In general, the reasonable cause standard applies to 1099 forms filed in 1990 and in later years.

In addition to keeping these terms in mind, you also need to keep in mind the general structure of the backup-withholding rules. When backup withholding first came into existence in late 1983, payors had two basic responsibilities. They were required to: (1) exercise due diligence in obtaining the payee’s correct TIN, and (2) backup withhold against interest payments to the payee in certain circumstances. To “backup withhold” means to withhold and remit to the IRS the current backup-withholding percentage of any interest payment to the payee’s account when required. The IRS regulations spelled out in great detail the numerous things payors had to do to meet these two basic requirements.

These regulations now spell out new and different things that payors must do to meet the new reasonable cause standard. However, payors should still try to have a good understanding of the due diligence standard. This is true for two reasons.

First, the due diligence standard applies to any 1099 forms required to be filed before 1990. This means that payors, at least for some time after 1990, will still need to be able to establish that they exercised due diligence, as the IRS attempts to assess penalties for 1099s the payor has filed in the past.

Second, the new reasonable cause standard has a “safe harbor” for payors who exercise due diligence as defined by the old rules. In other words, if a payor can show that it exercised due diligence as defined by the old rules, the payor will be deemed to have met the reasonable cause standard. Some payors may decide that it is simply easier to continue to operate under the due diligence standard than to learn the simpler reasonable cause standard.

This section, then, will review what you must do after account opening to meet your obligation to backup withhold and to meet either the due diligence standard or the reasonable cause standard. When we describe a payor’s responsibility, we will also discuss the source of the responsibility—whether it springs from the obligation to backup withhold or is a way of meeting either the due diligence or reasonable cause standard. All payors must meet responsibilities springing from the obligation to backup withhold. Payors do, however, have a choice of complying either with the due diligence or reasonable cause standards. Therefore, while it is important to know what you must do, it is equally important to know why you must do it—i.e., what obligations or standards you are meeting in doing it.

Let’s look now at our first topic—your responsibilities in handling a payee’s TIN.