Interim Guidance Relaxes Third Party Settlement Orgs' Backup Withholding Obligations

Notice 2011-42, 2011-23 IRB

In a Notice, IRS has provided interim guidance to third party settlement organizations (TPSOs) (as defined under Code Sec. 6050W and its regs) that eases their backup withholding obligations under Code Sec. 3406. TPSOs may rely on the interim guidance in the Notice until the current Code Sec. 3406 regs are amended to reflect this guidance.

Background. Under the backup withholding provisions of Code Sec. 3406(a)(1), certain payors must deduct and withhold income tax from a reportable payment—regardless of any threshold amount otherwise applicable to the payment—if the payee fails to furnish the payee's taxpayer identification number (TIN) or furnishes an incorrect TIN to the payor.

The Housing Assistance Tax Act of 2008, Div. C (P.L. 110-289) added Code Sec. 6050W, which for calendar years beginning after 2010 requires information returns to be made by certain payors for payments made in settlement of payment card transactions and third party payment network transactions. All payments made in settlement of payment card transactions are required to be reported under Code Sec. 6050W. Payments made in settlement of third party network transactions must be reported only if the amount to be reported exceeds $20,000 and the aggregate number of transactions exceeds 200 for any payee within a calendar year.

The Act also amended Code Sec. 3406(b)(3) by including as reportable payments potentially subject to backup withholding those payments required to be reported under Code Sec. 6050W, but without regard to that Code Section's reporting minimum thresholds. (Reg. §31.3406(b)(3)-5(b)) The withholding requirements under Code Sec. 3406 will apply to Code Sec. 6050W payments beginning Jan. 1, 2012.

The Code Sec. 3406 regs were amended to provide that whether payments made in settlement of third party network transactions were subject to withholding under Code Sec. 3406 is determined without regard to the statutory monetary or transactional thresholds found in Code Sec. 6050W. (Reg. §31.3406(b)(3)-5) Those monetary and transactional thresholds are considered solely for determining whether a TPSO had an information reporting obligation under Code Sec. 6050W for payments made to a payee. Accordingly, under the regs, TPSOs are required to obtain a TIN from every payee in a third party payment network, even the occasional small volume seller, to avoid backup withholding.

New guidance. In Notice 2011-42, IRS has determined that the Code Sec. 6050W statutory transactional threshold for determining information reporting obligations should be met before any Code Sec. 3406 withholding obligation arises for TPSOs. IRS intends to amend the Code Sec. 3406 regs to provide 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. Until the amended final regs are published, TPSOs may rely on Notice 2011-42 to limit any backup withholding obligations to payees who have exceeded the 200-transaction threshold.

Notice 2011-42 provides that the $20,000 monetary threshold in Code Sec. 6050W is not considered for purposes of determining backup withholding obligations.

The relief provided in Notice 2011-42 doesn't apply to payment card transactions. Under Code Sec. 6050W(c) and Code Sec. 6050W(d), a payment card transaction is any transaction in which a payment card is accepted as payment. A payment card is defined as any card that is issued pursuant to an agreement or arrangement that provides for: (a) one or more issuers of the cards; (b) a network of persons unrelated to each other, and to the issuer, who agree to accept such cards as payment; and (c) standards and mechanisms for settling the transactions between the merchant acquiring entities and the persons who agree to accept the cards as payment.

References: For reporting credit card sales, see FTC 2d/FIN ¶S-3699.18; United States Tax Reporter ¶60,50W4; TG ¶60212. For backup withholding, see FTC 2d/FIN ¶J-9000; United States Tax Reporter ¶34,064; TaxDesk ¶554,500; TG ¶9400.