Backup withholding is one of those compliance regimes most finance teams have heard of but few have actually implemented correctly. It is also one of the most common areas where US companies end up with surprise IRS penalties, often discovered only when an envelope from the IRS lands on the controller’s desk in November.
This guide is for US finance and operations teams paying 1099 contractors and other reportable payments to US persons. We walk through the four statutory triggers, the 24% rate, the CP2100 notice process, the First and Second B-notice procedures, the C-notice underreporting program, and how to stop backup withholding once it has started.
All claims are sourced from 26 USC section 3406, the Treasury Regulations at 26 CFR section 31.3406, IRS Publication 1281, the IRS backup withholding page, the IRS backup withholding B program page, and the IRS backup withholding C program page.
The Four Statutory Triggers
Backup withholding is a creature of IRC section 3406, enacted as part of the Interest and Dividend Tax Compliance Act of 1983 and refined many times since. Section 3406(a)(1) lists four exclusive triggers.
Trigger A: Failure to Furnish a TIN
The payee did not provide a TIN to the payer, or provided a TIN that is obviously invalid (fewer than 9 digits, more than 9 digits, contains non-numeric characters).
This is the most common trigger. A new contractor onboards, the company asks for a W-9, the contractor either ignores the request or fills in the form incompletely. The payer must begin backup withholding on the very first payment. There is no grace period.
The IRS backup withholding B program page confirms that the payer must begin backup withholding immediately when no TIN is provided or when the TIN is obviously incorrect.
Trigger B: IRS-Notified Incorrect TIN
The payer filed a 1099 information return with a TIN that does not match IRS records, and the IRS sent a CP2100 or CP2100A notice listing the mismatch.
This trigger does not require the payer to do anything until the IRS sends the notice. The notice typically arrives several months after the 1099 filing season. Once received, the payer must follow the B-notice procedure (described below) and begin backup withholding within a defined timeframe if the payee does not resolve the issue.
Trigger C: IRS-Notified Underreporting
The IRS notifies the payer (under the “C” Program) that the payee has been underreporting interest or dividends. This trigger applies only to interest and dividend payments, not to nonemployee compensation.
The C-Program procedure runs entirely on the IRS side. The IRS sends up to four notices to the payee over a 120-day period giving them an opportunity to resolve the underreporting. Only if the payee fails to resolve it does the IRS then notify the payer to begin backup withholding.
The IRS backup withholding C program page describes the process. For most contractor-payment scenarios, the C-Program is not relevant because it applies only to interest and dividends.
Trigger D: Payee Certification Failure
For interest and dividend accounts opened after 1983, the payee must certify on Form W-9 that they are not subject to backup withholding under section 3406(a)(1)(C). If they fail to make this certification, backup withholding applies.
This trigger is operationally bundled into the standard W-9 collection process for interest and dividend accounts and is generally invisible for normal contractor payments.
The 24% Rate
IRC section 3406(a)(1) ties the rate to “the fourth-lowest rate of tax applicable under section 1(c).” After the Tax Cuts and Jobs Act of 2017 restructured the individual income tax brackets, that fourth-lowest rate became 24%. The IRS backup withholding page confirms the current rate. Before the TCJA, the rate was 28%. Companies still using legacy templates referencing 28% are out of date.
The rate applies to the gross amount of the reportable payment. A company paying a $5,000 invoice to a contractor subject to backup withholding withholds $1,200 and pays the contractor $3,800. The withheld amount is deposited with the IRS on a regular schedule, reported on Form 945 at year-end, and shown in Box 4 of the contractor’s 1099-NEC.
What Payments Are Reportable
Backup withholding applies only to “reportable payments” as defined in IRC section 3406(b). The major categories are:
- Interest payments under IRC section 6049
- Dividend payments under IRC section 6042
- Patronage dividends under IRC section 6044
- Other payments required to be reported under section 6041 (most 1099-MISC and 1099-NEC payments)
- Service compensation under section 6041A (nonemployee compensation, the heart of 1099-NEC)
- Broker proceeds under section 6045
- Royalty payments under section 6050N
- Payment card and third-party network transactions under section 6050W (1099-K)
For a typical US company paying contractors, the relevant category is section 6041A nonemployee compensation. A payment that would be reported on Form 1099-NEC is a reportable payment for backup withholding purposes.
The CP2100 and CP2100A Notice
The starting point for trigger (B) is the CP2100 or CP2100A notice.
After the IRS processes the 1099 information returns filed for a year, it cross-checks the name/TIN combinations against its master files. Any 1099 with a missing or mismatched TIN is flagged. The IRS then sends the payer a list of the flagged returns.
The notice comes in two volumes:
- CP2100. Sent to payers with 50 or more mismatches. Delivered on magnetic media or via a secure download.
- CP2100A. Sent to payers with fewer than 50 mismatches. Delivered on paper.
Both notices contain the same information: a list of the names, TINs, and account numbers of payees whose 1099s contained errors. The notice does not by itself trigger backup withholding. It triggers the payer’s obligation to follow the B-notice procedure.
The Understanding your CP2100 or CP2100A Notice page describes the notice in detail.
The First B-Notice Procedure
When a payee is listed on a CP2100 or CP2100A notice for the first time, the payer must send the payee a “First B-Notice” within 15 business days of the date of the notice (or the date the notice was received, whichever is later).
The First B-Notice has a specific required content set out in IRS Publication 1281, including the template language. The notice must:
- Tell the payee their TIN does not match IRS records
- Warn that backup withholding will start within 30 business days unless corrected
- Enclose a Form W-9
- Ask the payee to certify their correct TIN by completing the W-9
If the payee returns a properly completed W-9 with a TIN within 30 business days, backup withholding is not required. The payer files the new W-9, validates it (typically through TIN Matching with the IRS), and continues paying without withholding.
If the payee does not respond, backup withholding must start on the next payment after the 30 business day window closes and continue until the payee provides a corrected W-9.
The Second B-Notice Procedure
If the same payee appears on a CP2100 or CP2100A notice a second time within three years, the standard new-W-9 fix is no longer sufficient. The payer must send a “Second B-Notice” with stricter requirements.
Under IRS Publication 1281 and the IRS backup withholding B program page, the Second B-Notice tells the payee that to stop backup withholding they must provide one of:
- A copy of their Social Security card (for individuals using an SSN as the TIN)
- A copy of IRS Letter 147C confirming the name and TIN combination (for entities using an EIN)
A new W-9 alone is not enough. The payee must verify the TIN with the original issuing authority (SSA for SSNs, IRS for EINs).
The 30 business day timeline applies the same way. If the payee does not provide the required verification within the window, backup withholding starts.
The C-Notice Procedure (Underreporting)
The C-Program is operationally simpler from the payer’s perspective because the IRS does most of the work.
Under IRC section 3406(a)(1)(C) and the IRS backup withholding C program page, the IRS identifies taxpayers who have underreported interest or dividend income on their personal returns. The IRS then sends up to four notices to the underreporting taxpayer over a 120-day period.
If the taxpayer fails to resolve the underreporting, the IRS notifies the payer directly. The payer must begin backup withholding on future interest or dividend payments to that payee. The payer continues backup withholding until the IRS notifies them that the taxpayer is no longer liable.
The C-Program applies only to interest and dividends. It does not apply to nonemployee compensation on 1099-NEC, so for most contractor-payment scenarios it is not relevant.
How Backup Withholding Stops
Each trigger has its own stop condition.
Trigger A (no TIN). Stops when the payee provides a properly completed W-9 with a valid TIN. The next payment after the W-9 is received is no longer subject to backup withholding.
Trigger B (incorrect TIN). For First B-notice cases, stops when the payee returns a corrected W-9. For Second B-notice cases, stops when the payee provides SSA or IRS verification of the correct name/TIN combination.
Trigger C (underreporting). Stops only when the IRS sends a separate notice to the payer indicating that the payee is no longer liable. The payer cannot decide to stop backup withholding on its own.
Trigger D (certification failure). Stops when the payee completes the certification on Form W-9.
In all cases, the stop date is forward-looking. Backup withholding that has already been done on prior payments is not refunded to the payee by the payer. The payee claims a credit for the withheld amount on their personal income tax return, against their total income tax liability for the year.
Reporting and Depositing the Withheld Amount
Backup-withheld amounts are deposited with the IRS on the same schedule as payroll federal income tax (monthly or semiweekly per IRS Publication 15) through EFTPS, reported annually on Form 945 due January 31, and shown in Box 4 of each affected contractor’s 1099-NEC. The deposit obligation is independent of the contractor relationship. Once triggered, the company owes the IRS 24% of every affected payment regardless of whether the contractor agrees.
Operational Setup for a US Company
The clean operational pattern for backup withholding looks like this.
At onboarding. Collect a complete and signed Form W-9 from every US-person contractor before the first payment. Validate the TIN through the IRS TIN Matching program (or a service that runs TIN matching) before approving the payment.
At each payment. Confirm that a valid W-9 is on file. If not, withhold 24% by default. The default is withholding, not paying gross. We cover the W-9 process in our Form W-9 guide for US companies.
At CP2100 receipt. Process the notice within 15 business days. Send First B-notices to first-time listings, Second B-notices to repeat listings. Track the 30 business day window. Begin backup withholding on the next payment after the window expires if the payee has not responded.
At deposit time. Aggregate backup withholding across all affected contractors. Deposit via EFTPS on the required schedule.
At year-end. File Form 945 by January 31. Report each contractor’s backup-withheld amount in Box 4 of their 1099-NEC.
A modern contract management platform handles W-9 collection, TIN matching, B-notice tracking, and backup withholding deposit scheduling as part of normal contractor workflow. The withholding is computed per invoice, the deposit schedule is generated automatically, and Form 945 and 1099-NEC are produced from the same underlying data.
Common Mistakes
Ignoring CP2100 notices. The notice arrives, gets routed to the wrong inbox, and sits for months. By the time anyone notices, the 15 business day First B-notice window has passed.
Sending the wrong B-notice. A repeat-listing payee gets a First B-notice template when they should get a Second B-notice. The payee returns a new W-9 thinking the issue is resolved, but the company has not actually fulfilled its Second B-notice obligation.
Confusing backup withholding with chapter 3 withholding. Backup withholding applies to US persons. Foreign persons get chapter 3 withholding (default 30%, reducible by treaty). A foreign contractor without a TIN is subject to 30% chapter 3 withholding, not 24% backup withholding. We cover the distinction in our 1099-NEC vs W-8BEN guide.
Using a 28% rate. The rate has been 24% since 2018. Templates and payroll systems still showing 28% are wrong.
Stopping backup withholding without authorization. Once started, backup withholding only stops when the right document is received (corrected W-9 for First B-notice, SSA/IRS verification for Second B-notice, IRS stop notice for C-Program).
Penalties for Getting It Wrong
The penalty structure layers across multiple failures.
Failure to deposit. Under IRC section 6656, the penalty is 2% for deposits up to 5 days late, 5% for 6 to 15 days late, 10% for more than 15 days late, and 15% if not deposited within 10 days after the first IRS notice.
Failure to file Form 945. Under IRC section 6651, 5% of unpaid tax per month, up to 25%.
Failure to file or furnish 1099 with backup withholding shown. Under IRC sections 6721 and 6722, penalties per form, indexed for inflation, applied separately for the IRS copy and the recipient copy.
Personal liability. If the company fails to deposit backup withholding, individual responsible persons can be held personally liable under IRC section 6672 (the trust fund recovery penalty), though this is most often applied to payroll withholding.
The penalties are per failure, per form, per year, and stack. A company that ignored backup withholding on 30 contractors for two years can face penalties exceeding $100,000 even before counting the underlying withholding obligation.
The Bottom Line
Backup withholding is not optional and not obscure. It is a strict-liability regime that requires payers to withhold 24% from reportable payments when a payee has TIN or underreporting issues. The rules are codified in IRC section 3406 and operationalized through CP2100 notices and the B-notice / C-notice procedures in Publication 1281.
For US companies paying 1099 contractors, the single most useful operational rule is to refuse to pay a US-person contractor without a valid W-9 on file. The default is withholding, not paying gross. A clean W-9 at onboarding eliminates 90% of backup withholding exposure before it ever starts.
If your finance team wants the W-9 collection, TIN matching, B-notice tracking, and backup withholding deposit workflow handled as a single platform, take a look at our Contract Management product. The pricing page covers the per-contract cost.