When a person, such as an employer, makes payments to another person, they must withhold and then pay a specified percentage of this payment to the Internal Revenue Service (IRS). This is called backup withholding. These payments have conditions set by the IRS, and there are many variables regarding what type of payments backup withholding can apply to.

Backup withholding payments can apply to most payments that are reported on an IRS Form 1099. These can include interest payments and payments by brokers, as well as royalty payments. Other payments may include dividends, patronage dividends if at least half the payment is in money, rents, and profits. Commissions, fees, or payments for work undertaken as an independent contractor may also be liable to backup withholding.

There are certain cases for which backup withholding payments can be excluded. These include real estate transactions, abandonments, foreclosures of properties, and cancelled debts. Other exceptions are care benefits, fish purchases for cash, unemployment compensation, state or local income tax refunds, and distributions from an employee stock ownership plan (ESOP).

A payment must be a reportable interest or dividend payment, if that dividend is paid in money or qualified check, in order to be subject to backup withholding, as set out in section 6049(a), 6042(a), or 6044. Any other reportable payment, as set out in section 6041, 6041(a), 6045, 6050A, or 6050N, will also be subject to backup withholding.

Reportable payments subject to backup withholding include the payee failing to supply his or her taxpayer identification number (TIN). If the payee has supplies an incorrect TIN, then backup withholding also applies. When payments for interest and dividend accounts or interest, dividend, and broker exchange accounts have been acquired after 1983 and the payee has failed to supply a correct TIN, backup withholding also applies.

A payer may receive a CP2100 or CP2100A. This is a notice informing the payer that he or she may be responsible for backup withholding. It will be accompanied by a list of incorrect, missing, or not received payee TINs. Large volume filers receive a CP2100, while all other filers receive the CP2100A notice. At the moment, the backup withholding rate (BWH Rate) is 28.0% for payments from 31 December 2002 through 31 December 2010, but it may be liable to change after this date.