PART 35a—TEMPORARY EMPLOYMENT TAX REGULATIONS UNDER THE INTEREST AND DIVIDEND TAX COMPLIANCE ACT OF 1983 Authority: 26 U.S.C. 7805; § 35a.3406-2 also issued under 26 U.S.C. 3406(c)(3)(D) and 3406(i). § 35a.3406-2 Imposition of backup withholding for notified payee underreporting of reportable interest or dividend payments. (a) Requirement that a payor backup withhold due to a notified payee underreporting In general. (2) Definition of notified payee underreporting. (i) Determined that there was a payee underreporting as defined in paragraph (a)(3) of this section, (ii) Mailed at least four notices to the payee (over a period of at least 120 days) with respect to the underreporting as prescribed in paragraph (f)(1) of this section, and (iii) Assessed any deficiency attributable to the underreporting in the case of any payee who has filed a return. (3) Definition of a payee underreporting. (i) A payee failed to include in his return of tax under chapter 1 of the Internal Revenue Code for such year any portion of a reportable interest or dividend payment required to be shown on such tax return, or (ii) A payee may be required to file a return for such year and to include a reportable interest or dividend payment in such return, but failed to file such return. See paragraph (a)(5) of this section for certain payments to be taken into account in determining whether there is payee underreporting even though those payments may not be defined as reportable interest or dividend payments in paragraph (a)(4) of this section or even though backup withholding under section 3406(a)(1)(C) may not apply to such payments. (4) Definition of a reportable interest or dividend payment In general. (ii) Exceptions Patronage dividends. (B) Window payments. (5) Reportable interest or dividend payments excluded from backup withholding. (i) Certain dividends. (ii) Minimal payments. (iii) Original issue discount. (iv) Payments subject to other withholding. Reportable minimal payments (to the extent reported on an information return), patronage dividends, original issue discount, and window payments shall be taken into account in determining whether underreporting (as defined in paragraph (a)(3) of this section) has occurred, even though those payments may not be defined as reportable interest or dividend payments under paragraph (a)(4) of this section or even though backup withholding under section 3406(a)(1)(C) may not apply to such payments. (6) Definition of payor. (7) Definition of broker. (b) Notice to payors and brokers regarding backup withholding Notice from the Internal Revenue Service. (i) Payors to begin backup withholding on reportable interest or dividend payments due to a notified payee underreporting pursuant to section 3406(a)(1)(C); and (ii) Brokers pursuant to section 3406(c)(5) that a payee is subject to backup withholding under section 3406(a)(1)(C). (2) Notice from a broker. (3) Accounts subject to backup withholding. In general. (ii) Joint accounts. (iii) Exception. (c) Notice from payors of backup withholding due to a payee underreporting In general. (2) Form of the notice to the payee with respect to notified payee underreporting. (i) That the Internal Revenue Service has given notice that the payee has underreported reportable interest or dividends; (ii) That, as a result of such underreporting, the payor is required under section 3406(a)(1)(C) of the Internal Revenue Code to withhold 20 percent of reportable interest and dividend payments made to the payee no later than the close of the day 30 days after the date that the payor received the notice; (iii) The date that the payor received the notice to begin backup withholding under 3406(a)(1)(C); (iv) That the payee must obtain a determination from the Internal Revenue Service in order to stop the backup withholding under section 3406(a)(1)(C); and (v) That while he is subject to backup withholding due to payee underreporting, the payee may not certify to a payor making reportable interest or dividend payments (or to a broker acquiring a readily tradable instrument for the payee) that he is not subject to backup withholding under section 3406(a)(1)(C). See section 3406(a)(1)(D) for the backup withholding rules with respect to a payee's failure to make the certification under section 3406(a)(1)(D). (3) Exceptions. (d) Notice to stop backup withholding In general. (2) Date notice to stop withholding will be provided Underreporting corrected or bona fide dispute. (ii) No underreporting or undue hardship. (e) Period during which withholding is required In general. (2) Stop date Underreporting corrected or bona fide dispute. (A) January 1 following the 12-month period ending on October 15th of any calendar year in which the determination has been made or, if later, (B) The day that is 30 days after the earlier of— ( 1 ( 2 (ii) No underreporting or undue hardship. (iii) Payor election to shorten or eliminate grace period. i.e., (iv) Examples. Example 1. The Internal Revenue Service makes a determination by October 15, 1987, that any underreporting with respect to A has been corrected. X, a payor who has been notified to backup withhold on payments of interest to A due to notified payee underreporting, receives written notice from the Internal Revenue Service on December 1, 1987, informing X that A is no longer subject to backup withholding under section 3406(a)(1)(C) and that X must stop backup withholding as of the close of December 31, 1987, or if later, the earlier of the close of the day 30 days after receipt of the notice from the Internal Revenue Service or receipt of the copy of the written certification provided to the payee by the Internal Revenue Service. The stop date, as provided in paragraph (e)(2)(i)(A) of this section, is January 1, 1988, and the payor must stop backup withholding as of the close of December 31, 1987. Example 2. Assume the same facts as in Example 1 Example 3. Assume the same facts as in Example 2 (f) Notice to payees from the Internal Revenue Service Notice period. (2) Payee subject to withholding. (i) A payee obtains a determination under paragraph (g) of this section, or (ii) In the case of a payee who has filed a tax return, the Internal Revenue Service has not assessed the deficiency attributable to the underreporting. (3) Disclosure of names of payors and brokers. (4) Backup withholding certification. (g) Determination by the Internal Revenue Service that backup withholding should not start or should be stopped In general. (i) Shows that there was no payee underreporting (as provided in paragraph (g)(2) of this section); (ii) Corrects any payee underreporting (as provided in paragraph (g)(3) of this section); (iii) Shows that backup withholding will cause or is causing an undue hardship (as defined in paragraph (g)(4) of this section) and that it is unlikely that the payee will underreport interest or dividend payments again; or (iv) Shows that a bona fide dispute exists as to whether any underreporting has occurred (as provided in paragraph (g)(5) of this section). (2) No underreporting. (3) Correcting any payee underreporting Before issuance of a statutory notice of deficiency. (ii) After issuance of a statutory notice of deficiency. (4) Undue hardship. (i) Whether estimated tax payments, and other credits for current tax liabilities, or amounts withheld on employee wages or pensions, in addition to backup withholding, would cause significant over-withholding; (ii) The payee's health, including the payee's ability to pay foreseeable medical expenses; (iii) The extent of the payee's reliance on interest and dividend payments to meet necessary living expenses and the existence, if any, of other sources of income; (iv) Whether other income of the payee is limited or fixed ( e.g., (v) The payee's ability to sell or liquidate stocks, bonds, bank accounts, trust accounts, or other assets, and the consequences of doing so; (vi) Whether the payee reported and timely paid the most recent year's tax liability, including interest and dividend income; and (vii) Whether the payee has filed a bankruptcy petition with the United States Bankruptcy Court. In addition to the above factors, the Internal Revenue Service must conclude that it is unlikely that any payee underreporting will occur again. (5) Bona fide dispute. (h) Requests for determinations In general. (2) Determinations made during the notice period. (3) Determinations made after the notice period. (i) [Reserved] (j) Payees filing a joint return In general. (2) Exceptions Innocent spouse. (A) Shows that he or she did not underreport income because he or she is an innocent spouse as described in section 6013(e), or (B) Shows that there is a bona fide dispute as to whether he or she is an innocent spouse and hence did not underreport income. (ii) Example. Example. H and W filed a joint return in 1986 on which H failed to include $2,000 of interest income. In 1987, the Internal Revenue Service determined that a payee underreporting exists with respect to H and W for the 1986 tax year. After properly notifying H and W of the underreporting and assessing the tax, the Internal Revenue Service sent notices to payors to begin backup withholding on the joint and individual accounts of H and W and to brokers informing them that H and W are subject to backup withholding under section 3406(a)(1)(C) on their joint and individual accounts. W claims that she is an innocent spouse and requests a determination that she did not underreport interest or dividend income so that her individual accounts will not be subject to backup withholding. The Internal Revenue Service questions her status as an innocent spouse. If the Internal Revenue Service determines, based upon all the facts and circumstances, that there is a reasonable basis for W's claim to be an innocent spouse and that the claim is made in good faith, W will have a bona fide dispute with the Internal Revenue Service. Consequently, the individual accounts of W will not be subject to further backup withholding due to a notified payee underreporting as provided in paragraph (g)(5) of this section. The Internal Revenue Service will notify payors to stop backup withholding under section 3406(a)(1)(C) and brokers that W is no longer subject to backup withholding under section 3406(a)(1)(C) on W's individual accounts. Backup withholding will not restart on those accounts unless the Internal Revenue Service ultimately determines that W is not an innocent spouse. In that event the Internal Revenue Service will notify the payors to start backup withholding under section 3406(a)(1)(C) and the brokers that W is subject to backup withholding under section 3406(a)(1)(C) with respect to the individual accounts of W. (iii) Divorced or legally separated payee. (k) Penalties Failure to withhold. (2) False certification Criminal penalty under section 7205(b). (ii) Civil penalty under section 6682 In general. (B) Waiver of penalty. ( 1 ( 2 (C) Procedure for seeking a waiver. (3) Delay of assessment. (l) Effective Date. [T.D. 8137, 52 FR 13432, Apr. 23, 1987, as amended at 60 FR 66134, Dec. 21, 1995; 61 FR 11308, Mar. 20, 1996]