What Is an Exempt Payee on a W-9?

Some workers, such as freelancers and independent contractors, receive payment from non-employer sources, called payers, for the work they do. Payers must report to the IRS any amounts in excess of $600 that they pay these workers, called payees, on a form 1099 information return. For a payer to ensure that he has the correct taxpayer information for the mandated IRS reporting, it’s the payer’s responsibility to obtain a completed Form W-9 - Request for Taxpayer Identification Number and Certification from the payee. Certain payees, whose income is not subject to backup withholding, are considered exempt payees as defined in the W-9 instructions.

How Backup Withholding Works

Backup withholding represents 24 percent of a payee’s compensation that a payer must withhold and send to the IRS for the payee’s income tax payment. The payee's earnings would not ordinarily be subject to withholding, but they become so under certain circumstances. Types of payments that potentially are subject to backup withholding include compensation paid to independent contractors, interest payments, dividends, rental income and royalty payments.

Circumstances That Require Backup Withholding

Certain circumstances that prompt payers to initiate backup withholding include:

  • A payee’s failure to give the payer a Taxpayer Identification Number (TIN).
  • A mismatch of the TIN that a payee reports to a payer with IRS records.
  • A payee’s under-reporting of interest or dividends on her tax return. In this circumstance, the IRS notifies the payer to begin backup withholding after the IRS notifies the payee four times in a 120-day period.
  • A payee’s failure to certify that she is not subject to backup withholding when under-reporting payments of interest and dividends.

Preventing or Stopping Backup Withholding

If a payer notifies a payee that her TIN is incorrect, preventing backup withholding may be as simple as the payee’s immediately correcting his TIN. A payee may need to resolve her under-reported income by paying the IRS what she owes in income tax to stop backup withholding. If the problem is a simple oversight because the payee failed to note an exempt payee code on Line 4 of her W-9, she can simply submit a corrected W-9 to the payer and/or submit a corrected tax return to the IRS.

Exempt Payee Codes

Most individuals, such as sole proprietors, are not exempt from backup withholding. Some corporations are also not exempt, except those noted in the W-9 instructions.

The W-9 instructions list 13 numbered exempt payee codes that must be entered on Line 4 to verify the exempt status for backup withholding.

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