Backup Withholding

• To understand what an exempt payee is, you first have to understand backup withholding. In certain circumstances payers must withhold a certain amount for taxes, known as backup withholding, to be remitted to the IRS. Payments that could be subject to backup withholding are interest, dividends, patronage dividends, royalties, rent and nonemployee pay, that is, most payments requiring a 1099 to be sent to the payee. However, backup withholding is required only when the payee does not provide his name or taxpayer identification number (TIN), or the TIN on the W-9 does not match IRS records, for payments over $600; if the taxpayer did not report all interest, dividend or other subject payments on his tax return or if the taxpayer owes federal income tax.
  
  

Exempt Payee Defined

• An exempt payee is a payee not subject to backup withholding even when backup withholding would normally be required. Exempt payees are outlined in the instructions provided by the IRS for completing the standard W-9 form, which is the form payers use to request your taxpayer identification number. In general, exempt payees include government agencies, charitable organizations, financial institutions, corporations and trusts. Individuals, including sole proprietors, generally are not exempt from backup withholding and, thus, are not exempt payees.
  
  

Impact

• When you fill out a W-9, there is a box where you must indicate whether you are an exempt payee. If you do not check the box, the payer will assume you are nonexempt and will withhold the required taxes if you fall into one of the categories where backup withholding is required.
  
  

State Taxes

• Rules on paying state taxes will vary depending on the state of residence. Payees should check the rule for their particular state. You may want to seek the help of an accountant or tax professional to determine whether you are subject to backup withholding and whether you are considered exempt or nonexempt.