In IRS Notice 2011-42 issued in May, 2011, the IRS provided interim guidance for "third party settlement organizations" (TPSO) in regard to backup withholding on payments to its participating payees. The Notice eases backup withholding obligations for TPSOs, who may rely on this interim guidance until Code Sec. 3406 regs are amended to reflect this guidance.

BACKGROUND FACTS

Under the existing backup withholding provisions of Code Sec. 3406, certain payers are required to deduct and withhold income tax from a reportable payment if the payee fails to furnish their correct TIN, regardless of any threshold amounts otherwise applicable to the payment.

New (2008) Code Sec. 6050W requires information returns (1099-K) to be made by certain payers for payments made in settlement of payment card transactions and third party payment network transactions effective for calendar years beginning after 12/31/10. All payments made in settlement of payment card transactions are required to be reported under Code Sec. 6050W (Form 1099-K). Payments made in settlement of third party network transactions must also be reported, but only if the amounts to be reported exceeds $20,000 AND the aggregate number of transactions exceeds 200 for any payee within a calendar year.

Section 6050W also amended Sec. 3406 by stating that payments required to be reported under Section 6050W were subject to backup withholding, but without regard to Section 6050W's minimum reporting thresholds referred to above. Further, Sec. 3406 regs were amended to provide that whether payments made in settlement of third party network transactions were subject to backup withholding is determined without regard to the minimum reporting thresholds of Code Sec. 6050W. Those thresholds are considered solely for determining whether a TPSO had an information reporting obligation to a payee. Accordingly, under the regs, TPSOs must obtain a TIN from each payee in a third party payment network to avoid backup withholding requirements.

NEW GUIDANCE – NOTICE 2011-42

With IRS Notice 2011-42 , the IRS provides that the Sec. 6050W 200 transactions threshold for determining information reporting obligations should be met before any Code Sec. 3406 withholding obligation arises for TPSOs. Notice 2011-42 guidance eases requirements so that no backup withholding is required where the aggregate number of transactions between a TPSO and a payee does not exceed 200 within a calendar year.

Notice 2011-42 makes clear however that the $20,000 minimum reporting threshold in Code Sec. 6050W is not considered for purposes of determining backup withholding obligations.

Note that the relief provided in Notice 2011-42 applies only to third-party settlement organizations. It doesn't apply to payment card transactions subject to backup withholding, which do not have minimum threshold limits.

At present there is some confusion about how the withholding should be applied once the 200 transaction limit is reached for a given payee. It is not clear whether backup withholding would only be required for payments subsequent to the 200 limit being reached, or whether it must be applied to all payments for the calendar year.