The IRS requires businesses to obtain a Form W-4 from each employee, and also a Form W-9 from contractors and others who may receive payments for services. If a business does not receive these forms, the business must deduct and withhold “back-up withholding” from all wage and other payments to these individuals equal to 24% of the payments (down from 28% prior to 2018). Amounts withheld from an employee/contractor’s payments as back-up withholding are reported on Forms W-2/Form 1099 by the business, and should be reported as federal income tax withheld on the employee/contractor’s income tax return.
As long as a business has secured a Form W-4 or Form W-9, the business may rely on these forms and is exempt from back-up withholding on payments to an employee or contractor, unless otherwise notified by the IRS. However, if a business has not secured a Form W-4 from an employee, or a Form W-9 from a contractor, and the business then makes wage or other payments to these individuals, if the business is audited by the IRS the business will then owe back-up withholdings to the IRS. If the employee is no longer working for the business, or the contractor is gone, this back-up withholding tax is then the employer’s tax to pay.
Particularly with IRS audits, and where the IRS asserts that the business owes back-up withholding on payments made to employees or contractors, the employer can avoid back-up withholding liability if the business is able to have the employee or contractor sign a certification that the employee or contractor was exempt from withholding or that the employee or payee has otherwise reported the payments received by the business as income for federal tax purposes. The IRS may accept a Form W-9 from a service provider in an audit, reflecting the service provider is exempt, or certification can made on Form 4669, Statement of Payments Received. Form 4669 requires that the employee or contractor list each payment received during the year and certificates that each payment has been reported on the employee or contractor’s income tax return.
Back-up withholding is not something to be taken lightly. A business should always request and receive a Form W-4 from its employees, and a Form W-9 from each contractor or other service provider to whom it will make payments. Failure of a business to receive these forms can subject the business to a 24% tax on all payments made to these individuals, and if the employee or contractor is gone, this tax is borne by the business.