Backup Withholding and Form W-9: When You Must Withhold 24% from Contractor Payments

By Yarik Yarosh, CPA ·September 5, 2026 ·Updated September 23, 2026 ·6 min read

Written by Yarik Yarosh, CPA (US & Canada) September 5, 2026 · FL CPA license AC61704 · CPA Ontario

Form W-9 is the most frequently used and least understood IRS form in small business operations. Every business that pays an independent contractor $2,000 or more in a year (for 2026 payments; $600 for 2025 payments) must collect a W-9 before making the first payment and file a 1099-NEC reporting the payments. But the real consequence of not collecting a proper W-9 is backup withholding: the business must withhold 24% of every payment to the contractor and remit it to the IRS. This is not optional, and the penalties for failing to backup withhold when required are significant.

✓Key takeaway

Backup withholding rules:

When backup withholding is required (IRC 3406):

The payee (contractor) fails to provide a taxpayer identification number (TIN) on Form W-9
The IRS notifies you that the TIN provided is incorrect (B-notice or CP2100/CP2100A notice)
The IRS notifies you that the payee is subject to backup withholding for underreporting
The payee fails to certify that they aren’t subject to backup withholding

The rate. 24% of the payment amount, withheld at the time of each payment.
Depositing the withholding. Backup withholding is deposited using EFTPS (Electronic Federal Tax Payment System) with Form 945. The deposits follow the same schedule as payroll tax deposits (monthly or semi-weekly, based on total backup withholding liability).
Reporting. Amounts withheld are reported on:

Form 1099-NEC (box 4) for the contractor
Form 945 for the IRS (annual return of backup withholding)

W-9 collection timing. Collect the W-9 before the first payment. If you cannot get a W-9, you must begin backup withholding immediately. Paying first and “planning to get the W-9 later” creates an immediate backup withholding obligation.
Penalties for failing to backup withhold when required:

The business is liable for the 24% that should have been withheld, plus interest
Penalty of $340 per information return not filed (for missing or incorrect 1099s due in 2026)
If willful, penalties increase significantly

Common mistakes:

Paying a contractor all year and collecting the W-9 in January for 1099 filing (backup withholding was required from payment 1)
Accepting a W-9 with no TIN and continuing payments without withholding
Ignoring IRS B-notices about incorrect TINs
Not filing Form 945 even when no backup withholding was collected (if you received a B-notice, you may need to file)

What does the B-notice process look like?

Hypothetical example

Round numbers. A business pays 20 independent contractors during the year, totaling $300,000 in 1099-NEC payments. In March, the IRS sends a CP2100A notice (first B-notice) indicating that 3 contractors provided incorrect TINs.

Response timeline:

Within 15 days of receiving the notice: Send each contractor a “B-notice” letter requesting a corrected W-9 (the IRS provides a template)
The contractor has 30 days to respond with a corrected TIN
If the contractor provides a corrected TIN: File a corrected 1099-NEC and stop backup withholding
If the contractor doesn’t respond within 30 days: Begin backup withholding at 24% on all future payments

Financial impact for one non-responsive contractor earning $50,000:

Backup withholding: $50,000 x 24% = $12,000
The $12,000 is paid to the IRS on behalf of the contractor
The contractor receives $38,000 instead of $50,000
The contractor can claim the $12,000 as a credit on their tax return
If the business failed to withhold: the business owes the $12,000 plus interest

Second B-notice (for the same contractor in a subsequent year):

The contractor must provide a TIN verified by the IRS or Social Security Administration
A self-certified W-9 alone isn’t sufficient after a second B-notice
Backup withholding continues until the IRS confirms the corrected TIN

Best practice: build W-9 collection into your onboarding process. No W-9 = no first payment. Use a digital W-9 collection tool that validates TIN format (though it can’t verify accuracy, only format).

Illustrative numbers only, not a real client and not advice for your facts.

What are the penalties for failing to file 1099s?

The penalty for failing to file a correct information return (including 1099-NEC and 1099-MISC) is $60 per return if filed within 30 days of the due date, $130 if filed after 30 days but by August 1, and $340 per return if filed after August 1 or not at all (amounts for returns due in 2026). Small businesses (average annual gross receipts of $5 million or less) get lower annual maximums, not lower per-return amounts. If the failure is due to intentional disregard of the filing requirement, the penalty increases to the greater of $680 per return or 10% of the amounts that should have been reported, with no maximum. You must also furnish the payee statement (the recipient’s copy) by January 31, and a separate penalty schedule applies for failure to do so. The backup withholding rules (IRC 3406) require you to withhold 24% from payments to any payee who fails to provide a valid TIN on Form W-9.

How does the ABC test differ from the IRS common-law test for worker classification?

The IRS common-law test examines three categories (behavioral control, financial control, relationship type) with no single factor being decisive (the 20 factors from Rev. Rul. 87-41 remain an older reference, not the test). The ABC test, a state-law test, presumes a worker is an employee unless the hiring entity proves all three conditions: (A) the worker is free from control and direction, (B) the work is outside the usual course of the business, and (C) the worker is independently established in that trade. The ABC test is harder for businesses to satisfy because it requires meeting all three prongs, while the common-law test is a balancing analysis. California (AB5) uses the ABC test, with exemptions for some workers; other states’ rules vary.

Related guides:

Backup Withholding (IRC 3406): When and Why the IRS Withholds 24% From Your Payments

Does a signed W-9 prove a worker is really a contractor?

No. A W-9 gives you the worker’s tax ID so you can file a 1099, but the IRS decides status from the substance of the relationship. If you control when, where and how the person works and you supply the tools, a W-9 and a 1099 won’t stop a reclassification.

What the paperwork does is limit the damage. When the required 1099s were filed, the income tax and employee FICA you didn’t withhold are figured under IRC 3509 at 1.5% of wages and 20% of the worker’s FICA share. Without them, and without reasonable cause, it’s 3% and 40%. The employer’s own 7.65% FICA and FUTA are owed in full either way.

Filed 1099s are also a condition of Section 530 relief and of the Voluntary Classification Settlement Program, so a business that collects W-9s but never files the 1099s loses both.

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Cite this page

Yarik Yarosh, CPA. "Backup Withholding and Form W-9: When You Must Withhold 24% from Contractor Payments." Blue Cloud CPA, September 5, 2026, updated September 23, 2026. https://bluecloudcpa.com/guides/small-business-backup-withholding-form-w9

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.