U.S. taxpayers at risk of getting a chunk of investment income withheld now have a chance to stop it from happening.
The Internal Revenue Service is fully operating, at least temporarily, meaning it will again issue letters to verify the identities of taxpayers who made errors on a key tax form. That could free up potentially billions of dollars that otherwise would go to a 24 percent tax that banks and asset managers must withhold from distributions if the taxpayer meant to receive it can’t get identity confirmation in time.
“Taxpayers in this situation need to go get the letter immediately,” said Danielle Nishida, principal of KPMG’s information reporting and withholding group. “There’s a possibility the government will be shut down again. You don’t know what’s going to happen three weeks from now.”
The IRS was operating at about half staffing during the shutdown, which ended Jan. 25 when President Donald Trump agreed to support a deal opening it for three weeks. That gives taxpayers a potentially brief window of time to get in touch with the agency.
Backup withholding is meant to ensure the IRS will eventually receive the money it is owed. The withholding tax could apply to anyone who receives passive investment income and uses an employer identification number on tax forms. That could be a small business owner or an investor expecting to receive dividends or proceeds from the sale of securities.
And though the tax hit would be substantial overall, the error causing it could be as small as a missing employer identification number, or the financial institution incorrectly entering the nine-digit string.
When a fund manager or bank sees a discrepancy on the Form W-9, it will send a warning, known as a ‘B-notice,’ to the taxpayer. If the taxpayer receives a second notice, they have 30 days to contact the IRS and get a verification letter.
The IRS and Treasury Department didn’t have immediate comments.
Financial institutions can be penalized for distributing funds to U.S. entities without properly verifying the taxpayer. The requirement is part of tax code Sections 6041- 6050W.
Small-business owners will suffer in particular from the withholding, said an insider in the securities industry who spoke with Bloomberg Tax on the condition of anonymity.
Taxpayers who have already had the money withheld will have to file their 2018 tax return and request a credit, tax practitioners said. The time it takes for the IRS to refund them will depend on how much else the agency is scrambling to do.
The IRS has spent more than a month operating with only 57 percent of its workforce. That means that it won’t immediately be able to move through the backlog of requests and messages it has received in that time.
Practitioners have in recent days been growing increasingly concerned about the building backlog at the agency.
That’s “going to slow down the response time even more than usual,” said Denise Hintzke, managing director at Deloitte.
Although the IRS hasn’t announced a safe harbor of some sort for taxpayers caught by the withholding tax, extra time for taxpayers to get the letters they need would be a welcomed reprieve, Hintzke said.
“It would be helpful if the IRS provide a few extra weeks before requiring backup withholding to be turned on so that taxpayers have time to rectify their situation,” she said.
Treasury on Jan. 16 said it won’t penalize taxpayers who underpaid their estimated taxes for 2018, as long as they paid 85 percent of what they owe through withholding or estimated quarterly payments.
“People may have to be a bit patient as the IRS employees settle back into their jobs,” Chip K. Collins, a managing director at UBS AG, said in an email. “Sure hope we don’t have to go through this again on Feb 15!”