HCUL TECHNICAL DATE PAGE ADVISORY GUIDE 5/14/04 IIIH 1 BACKUP WITHHOLDING

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1 ADVISORY GUIDE 5/14/04 IIIH 1 OVERVIEW Backup withholding is federally mandated by the Interest and Dividend Tax Compliance Act of The intent of the Act is to ensure that interest and dividends are reported under correct Tax Identification Numbers (TINs) to the Internal Revenue Service (IRS). Over the last twenty years several federal tax laws have required that certain financial information be reported so the government can determine if individuals and businesses are reporting accurate information on their tax returns. The information provided by the credit union must include a correct TIN to allow the IRS to match the information against income included on the payee s (i.e., account holder s) tax return. Backup withholding is when a payor (i.e., a credit union) withholds part of an interest or dividend payment. Under the law a credit union must do all of the following: 1. Withhold 28% of dividends paid on an account if one of four conditions exist on the account (the four conditions are explained on page 5 of this section); 2. Remit the withheld dividends to IRS; 3. Submit an annual report to IRS; AND 4. Include the withheld amount on IRS Form 1099-INT to the member and IRS. Backup withholding is the IRS way to get the taxpayer s attention. In order to stop backup withholding, the taxpayer (member) must provide the credit union with a correct or certified TIN or a credit union must receive clearance from IRS to stop. The amount that s withheld should be reported by the member on his/her tax return and is credited against taxes that the member owes.

2 ADVISORY GUIDE 3/08/07 IIIH 2 I. TAXPAYER IDENTIFICATION NUMBERS (TINS) A. Basic TINs There are basically two types of TINs: 1. Social Security Number issued by the Social Security Administration. Social Security Numbers have nine digits separated by two hyphens ( ). 2. Employer Identification Number issued by the Internal Revenue. Employer Identification Numbers (EIN) have nine digits separated by one hyphen ( ). A member s TIN will usually be his/her Social Security Number. A nonnatural member (i.e., corporation, trust or other entity) will usually use an Employer Identification Number for IRS reporting purposes. Many revocable living trusts and sole proprietorships will use the member s Social Security Number. IRS verifies whether a TIN is correct by matching it against a file containing all Social Security numbers issued by the Social Security Administration and a file containing all Employer Identification numbers issued by Internal Revenue. If the TIN and name combination matches IRS files, it s considered correct. If it doesn t match or can t be found, it s considered incorrect. If a member gives the credit union an incorrect name and/or TIN, the credit union will use incorrect information when reporting to the IRS. The credit union will not know if a member provided an incorrect TIN until notified by IRS.

3 ADVISORY GUIDE 5/14/04 IIIH 3 B. ITIN C. ATIN An ITIN is an individual taxpayer identification number issued by the IRS, and used by aliens (resident and nonresident), who are not eligible for SSNs. An ITIN has nine numbers in the same format as an SSN and always begins with the number nine (9). Form W-7, Application for IRS Individual Taxpayer Identification Number, is used to apply for an ITIN. The form is available at An ATIN is an adoption taxpayer identification number issued by the IRS. ATIN s are only a temporary tax identification number issued for a child born in the United States. An ATIN contains nine numbers in the same format as an SSN. An ATIN may be requested when an SSN cannot be obtained in time to file a tax return. Once the parent obtains an SSN, the ATIN is closed. Form W-7A, IRS Application for Taxpayer Identification Number for Pending U.S. Adoptions, is used to apply for an ATIN. The form is available at D. IRS TIN MATCHING PROGRAM IRS has a TIN matching program that allows payors (credit unions) to verify payee (member) TINs that are required to be reported in information returns. The TIN matching program was established in 1997 and only used by federal agency payors. The program was expanded in 2003 to include all payors and authorized agents of payors. The program is an online system that allows a credit union, before filing an information return, to check the TIN furnished by the member against the name/tin combination in the IRS data base. This data base is specifically maintained by the IRS for the matching program.

4 ADVISORY GUIDE 5/14/04 IIIH 4 The online program allows for 25 requests in real time or for a bulk file containing up to 100,000 TIN match requests that can be processed overnight through a secure mailbox. This system should not be used for verification purposes when opening new accounts. It should also not be used to determine whether to close an account. To register for the program, go to

5 ADVISORY GUIDE 5/14/04 IIIH 5 II. COMPLIANCE REQUIREMENTS FOR CREDIT UNIONS All state and federally chartered credit unions must comply with backup withholding if they: 1. Pay interest or dividends on members accounts; or 2. Are notified by IRS to impose backup withholding. Non-compliance can result in severe penalties. Interest or dividends totaling $10 or more paid to an account in a calendar year must be reported to the member and IRS on Form 1099-INT, Statement for Recipients of Interest Income. If a credit union backup withholds on an account, it must report the amount withheld on Form 1099-INT, Block 4 - Federal income tax withheld. Under the law a credit union must withhold and deposit with the IRS 28% of any interest/dividends paid to an account if any one of the following four conditions apply: 1. A member does not furnish a TIN to the credit union; 2. A member fails to certify on the W-9 form that backup withholding is not required; 3. IRS instructs the credit union to begin backup withholding due to an incorrect TIN; ( B notice) 4. IRS instructs the credit union to begin backup withholding due to a member s under-reporting of interest/dividend income. ( C notice)

6 ADVISORY GUIDE 5/14/04 IIIH 6 III. WHEN TO IMPOSE A. Missing TIN If an account has a missing TIN, the credit union should be performing backup withholding. A credit union is required to make an initial solicitation for a TIN when the member first opens an account. If the member does not provide a TIN at that time, the credit union must start backup withholding. Also, to avoid a penalty for filing an incorrect Information Return, the credit union must make a first annual solicitation by December 31 of the year the account was opened (for accounts opened before December) or January 31 of the following year (for accounts opened in December). If the member still doesn t provide a TIN after the first annual solicitation, the credit union must make the second annual solicitation by December 31 of the year following the calendar year in which the account was opened. If a credit union opens a new account for a member who doesn t have a TIN but has applied for one, the credit union does not have to backup withhold unless the member does not supply his/her TIN within sixty (60) days. When the member gets the TIN from Social Security, the member must furnish it to the credit union and certify the TIN on a Form W-9. The form is available at A credit union may refuse to open an account if the member does not provide his/her name and TIN, provides an incorrect TIN, or refuses to certify the TIN s accuracy. However, if the member only refuses to certify that he/she is not subject to backup withholding, the credit union must open the account and start backup withholding immediately. Backup withholding can be stopped when the member provides a proper TIN. However, if backup withholding was initiated due to several circumstances, it cannot stop until all circumstances have been satisfied. The credit

7 ADVISORY GUIDE 5/14/04 IIIH 7 union is not required to keep the TIN certification if it can demonstrate that it utilized procedures to obtain these certifications. However, it might be easier for the credit union to keep all TIN certifications (IRS Form W-9 s or substitute W-9 s) on file, regardless of when an account was opened. B. Member fails to certify that backup withholding is not required The member must complete a W-9 certification that backup withholding is not necessary, and sign the W-9 under penalties of perjury. If the certification and signature are not present, backup withholding must begin immediately and continue until a proper certification is completed. C. IRS notifies credit union to backup withhold due to an incorrect TIN ( B Notice) When the member s TIN as reported by the credit union is incorrect, IRS will notify the credit union. The IRS notice will be a CP2100 or a CP2100A. This is known as the B-notice requirement because of the section it falls under in the Internal Revenue Code. When the credit union receives an IRS CP2100 or CP2100A someone should work on it right away. The notice will include a list of incorrect TINs, taken from the information submitted by the credit union. The credit union should research why the TINs are incorrect : 1. Compare the information on the IRS list with internal records such as account cards or signed Form W-9s. Are they on the list because of a credit union error? Are the numbers transposed or the names misspelled to create an incorrect TIN? If yes, update internal records so future information returns to the IRS will be correct.

8 ADVISORY GUIDE 5/14/04 IIIH 8 2. Do not backup withhold or mail a B-Notice to the member. In this case, the member provided the correct name/tin but the credit union made a mistake when inputting the information into its system. 3. Is a TIN on the list because you updated your internal records after the information was submitted to IRS? If yes, do not backup withhold or mail a B-Notice to the member. Future information submitted to the IRS should now be correct. If information on the IRS list agrees with your records, you must first determine whether this is the first or second time within three calendar years that IRS has notified you that the TIN is incorrect. This will determine whether you should send the member a First or Second B-Notice. If you receive two B-Notices on the same account within three years (the 2/3 rule), you must backup withhold until you receive notification from the Social Security Administration (SSA) or the IRS that the name/tin combination is valid. The credit union must track accounts that require B- Notices. IRS Notices will not indicate whether it is the first or second notice for a specific account. 1. If this is the first notice from IRS: a) Within fifteen (15) business days from the date you received the IRS Notice, you must notify the member of the problem and ask for a new certified TIN. A business day is any day except Saturday, Sunday or legal holiday. b) Send the member a First B-Notice and a Form W-9. c) Date the B-Notice no later than thirty (30) business days from the date you received the IRS notice.

9 ADVISORY GUIDE 5/14/04 IIIH 9 d) The outer envelope must be clearly marked IMPORTANT TAX INFORMATION ENCLOSED or IMPORTANT TAX RETURN DOCUMENT ENCLOSED. e) You may send a reply envelope although you are not required to. f) Allow the member thirty (30) business days to provide you with a new signed W-9. g) When you receive the signed W-9, update your records with the corrected information and include it in future information returns to IRS. h) Keep the W-9 on file. Do not send the signed W-9 to the IRS. i) If the member does not respond within thirty (30) business days, identify the accounts involved, begin backup withholding and continue until you receive a new signed W-9. 1) How do you identify the accounts involved? If the B-Notice provides an account number, the credit union must only identify the accounts corresponding to that number with the same name/tin combination. 2) If the B-Notice doesn t provide an account number, the credit union must search for accounts with the same name/tin combination on their computer or other recordkeeping system. In the case of a joint account, the name/tin combination would be the one used for information reporting purposes (generally the first name on the account).

10 ADVISORY GUIDE 5/14/04 IIIH If this is the second notice from IRS for the same member, ask two questions: Is this the second notice received in the same calendar year as the first notice? If yes, no 2 nd B-Notice has to be mailed. If no, follow the instructions below. Is this the second notice in a different calendar year from the first notice, but both notices relate to the same payee s account for the same calendar year? If yes, no 2 nd B- Notice has to be mailed. If no, follow the instructions below. a) Within fifteen (15) business days from the date you received the IRS notice, send the member a Second B-Notice. b) Date the Second B-Notice no later than thirty (30) business days from the date you received the IRS notice. c) The outer envelope must be clearly marked IMPORTANT TAX INFORMATION ENCLOSED or IMPORTANT TAX RETURN DOCUMENT ENCLOSED. d) You may send a reply envelope although you are not required to. e) DO NOT SEND A FORM W-9 TO THE MEMBER. The member must contact the Social Security Administration to have a Social Security number validated or the IRS to have an EIN validated. It is the member s responsibility, not the credit union s, to contact Social Security or IRS to obtain the proper validation. f) Allow thirty (30) business days from the date of your request to receive either SSA Form 7028, Notice to Third Party of Social Security Number Assignment, from the SSA, or a copy of IRS Letter 147C from the member.

11 ADVISORY GUIDE 5/14/04 IIIH 11 g) If you don t receive SSA Form 7028 or IRS Letter 147c within the thirty (30) business days, begin backup withholding and continue until you receive either validation. D. C-Notice Requirements A credit union might receive an IRS Backup Withholding Notice that a member did not report or underreported dividend income. This is known as the C-Notice. When a credit union receives a C-Notice, someone should work on it right away. The credit union must begin backup withholding unless IRS notifies it otherwise or the member presents certified proof that the problem with the IRS has been resolved. Backup withholding must begin on the 31st day after the credit union receives a C- Notice. A credit union may elect to withhold anytime before the 31st day. A credit union must notify the member that a C- Notice was received. A sample notice to member is at the end of this section. The notice must be mailed within fifteen (15) days after the first dividend payment that s subject to backup withholding is made. The notice to the member should state that: 1. IRS notified the credit union that the member has underreported dividend and/or interest income; 2. The credit union must now withhold 28% of dividend payments to the member; 3. The member must get a determination letter from IRS to stop withholding: and 4. That while backup withholding is in effect, the member cannot certify to another payor that he is not subject to backup withholding.

12 ADVISORY GUIDE 5/14/04 IIIH 12 The credit union cannot stop backup withholding until IRS notifies it to stop or the member presents certified proof from the IRS that the underreported problem has been resolved. In most cases, the stop date will be January 1st of the year following the year of the notice. Note: The credit union may also stop backup withholding if it receives a notice from the Taxpayer Advocate Service. The Taxpayer Advocate Service is an independent IRS program that helps taxpayers resolve tax problems. IV. EXEMPT ACCOUNTS If a B-Notice from the IRS lists fiduciary or nominee accounts, the credit union is not required to backup withhold or include these accounts in a B-Notice mailing. An example of a fiduciary account is a custodial account for a minor. A nominee is a middleman known in the investment community and it s unlikely that a credit union would have a nominee account. B-Notice mailing and backup withholding are also not required for non-reportable payments (i.e., dividends less than $10 in the year) or payments to exempt recipients (i.e., a corporation, tax exempt organizations, IRS, U.S. agencies or instrumentalities). V. DORMANT ACCOUNTS For dormant accounts, there is a limit to the time that a credit union has to track the account for backup withholding. The requirements to backup withhold on an account ends no later than the end of the third calendar year after: 1) the date of the last reportable dividend payment made to the account, or if later 2) the close of the third calendar year after the receipt of the B-Notice. VI. JOINT ACCOUNTS

13 ADVISORY GUIDE 5/14/04 IIIH 13 The credit union is required to withhold on joint accounts only if the name that s listed in the IRS notice is shown as the first name on the account. However, after withholding begins, if the sequence of names is changed on an account, the credit union should continue to withhold until the IRS notifies the credit union to stop. If the IRS notice lists several co-owners, withhold on all accounts in joint names and any in which either coowner is named first. For example, if the co-owners listed are James and Alice Smith, withhold on all joint accounts of James and Alice, and any other accounts where James or Alice is named first. VII. DEPOSITING AND REPORTING REQUIREMENTS Regardless if a credit union is backup withholding on its own or is notified by IRS to backup withhold, the credit union must deposit the funds with IRS either semi-weekly or monthly and must report to IRS annually. Backup withheld funds used to be deposited together with funds withheld from payroll/wages. Effective December 31, 1993, IRS amended its rules by separating non-payroll from payroll withholding taxes, with separate depositing and reporting requirements. IRS revised its Form 8109, Federal Tax Deposit Coupon, to include a box for non-payroll taxes. IRS also came out with a new Form 945, Annual Return of Withheld Federal Income Tax, for the reporting of nonpayroll withholding. In addition to backup withholding, examples of non-payroll withholding taxes are from pensions, certain annuities, IRA s, military retirement and certain gambling winnings. IRS Form 945 is available at

14 ADVISORY GUIDE 5/14/04 IIIH 14 A. Depositing: Semi-weekly or Monthly There are two deposit schedules - semiweekly or monthly - for determining when to deposit the withheld funds. The schedules will tell when a deposit is due. Before the beginning of each calendar year, the credit union must determine which of the two deposit schedules to use. Beginning with calendar year 1996, a credit union s depositor status will be determined annually based on looking back to the amount of taxes reported on Form 945 for the second preceding calendar year. (called the lookback period) For example, for calendar year 1996 a credit union s depositor status will depend on the amount reported on Form 945 for calendar year If a credit union reported non-payroll withholding taxes of $50,000 or less on Form 945 for a lookback period, the credit union will be a monthly depositor for the calendar year. If the amount was over $50,000 the credit union will be a semi-weekly depositor. B. Reporting: Annually Non-payroll withholding taxes (including backup withholding) used to be reported on Form 941. Effective for amounts deposited after December 31, 1993 (in calendar year 1994), these taxes are to be reported annually on Form 945. The first filing of Form 945 was due January 31, 1995, only for credit unions that withheld these taxes. If a credit union did not withhold non-payroll taxes, no Form 945 had to be filed. But once a credit union files Form 945, it must file annually thereafter whether any non-payroll taxes have been withheld or not. Taxes withheld from payroll that are reported on Form 941 continue to follow the same depositing and reporting rules. The new Form 945 was created to keep payroll and non-payroll withholding separate.

15 ADVISORY GUIDE 5/14/04 IIIH 15 VIII. PENALTIES IRS can impose a $50 penalty on the credit union for each incorrect TIN, unless the credit union can show that it demonstrated due diligence or initiated backup withholding. In addition, if a credit union s failure to backup withhold is willful it could be liable for penalties of up to $500,000. If a credit union failed to make timely deposits of withheld funds it could also be subject to a penalty. The IRS can assess an interest penalty of five percent of the amount of any underpayment of funds that should have been deposited. IX. CONFIDENTIALITY The credit union should not use a member s backup withholding information for any purpose other than to comply with backup withholding requirements. The credit union could be subject to a civil penalty for misusing tax information. The credit union may NOT use a member s backup withholding information for the following: 1. To close a member s account 2. To impose a fee for backup withholding on the account 3. To refuse to open an account for the member or 4. To refuse to extend credit to the member X. DATA PROCESSOR Most data processors have some form of a backup withholding program so a credit union should not have to withhold dividends manually from a member s account. A credit union should understand how its data processor s backup withholding program works, what type of reports are produced, and be sure what s reported to IRS is in compliance.

16 ADVISORY GUIDE 5/14/04 IIIH 16 XI. FREQUENTLY ASKED QUESTIONS Q: What if a B-Notice is returned undeliverable? A: Try to get the correct address for the payee and r the notice. If you can t find the correct address, keep the undelivered notice with your records and start backup withholding on future dividend payments. Q: What if the credit union no longer does business with the payee or there was only one transaction? A: Send the payee a B-Notice and try to get a correct TIN. If you don t get a response, notate your records so if you do business again with the payee you can track IRS notices for the 2/3 rule (refer to page 8). IRS requires tracking of accounts for three years after the date of the first notice. Q: What if the first notice and Form W-9 are returned with the same incorrect information? A: If a payee returns the Form W-9 with the same incorrect information, keep the W-9 on file to show that the payee certified the name and TIN combination. Do not backup withhold. Q: Can a certification on one account be used to correct all accounts of a specific payee? A: Yes, if the payee used the same incorrect TIN on all accounts. Backup withholding applies to all existing accounts you can locate receiving reportable dividend payments. Q: What if the credit union has no record or account for a payee from whom the IRS had requested withholding? A: The credit union doesn t have to take any action.

17 ADVISORY GUIDE 5/14/04 IIIH 17 Q: How should the credit union handle withholding if the notice from the IRS lists co-owners? A: If the IRS notice to start withholding names several co-owners, withhold on all accounts in the co-owners joint names and any accounts in which either co-owner is named first. If the IRS notice names only one owner, withhold on all accounts showing that owner s name first. Q: Is a trust or estate account exempt from a B-Notice mailing? A: No. IRS clearly states on the W-9 instructions that the correct TIN should be that of the trust or estate.