IRS Fumbles Words on Backup Withholding

“I think they’re just checking Social Security numbers,” says one taxpayer, struggling to understand the W-9 tax form sent by his bank, “but the warnings included are Draconian--’Send this in or there’ll be fines and penalties!’--and something about withholding on interest, which I thought they repealed.”

“I asked my bank what it is,” said another, “and they said just ignore it.”

Both are right. Almost. Congress did repeal something, and one may be able to ignore it. But given the way it’s explained and carried out, who would know?

It all started with the 1982 Tax Equity and Fiscal Responsibility Act. One goal was to close what the IRS calls “tax gaps,” including unreported interest and dividends--an estimated loss to the national treasury of almost $8 billion in 1981. The act required banks, savings and loan associations, brokerage houses and mutual funds to withhold 10% of all interest earned by their customers, starting in mid-1983.

But by then it was repealed--thanks in part to banks and S&Ls;, many of which lobbied against it because they didn’t want the expense or responsibility of withholding. Its replacement--the 1983 Interest and Dividend Compliance Act--is no more popular, involving them almost as much in making sure the IRS gets its due.

Matter of Choice

The prime goal is to make these institutions get everyone’s “taxpayer identification number” (usually their Social Security number), so the IRS can claim its money. They withhold only as a “backup” on people who gave them an incorrect number or none at all, people the IRS says under-reported in the past, or were guilty of a “payee certification failure”--an odd crime explained as well as possible below.

Such institutions didn’t hide interest payments before, but they included a Social Security number in IRS reports only if a customer chose to provide it. And without it, the IRS found it very difficult to match interest to taxpayer, given similarity of names and changes of address (or the falsification of either).

What’s more, the IRS sees interest and dividend payments as the only way to discover a purposeful non-filer, someone who takes wages in cash and tries to bank them quietly. Now they can immediately and accurately cross-check whether a return was filed. There’s even the strong possibility, says IRS spokesman Robert Giannangeli in Los Angeles, that “if they’re forced to give their Social Security number, it has the effect of getting them to report.”

Financial institutions were given exact forms and procedures to use, all guaranteed to complicate a simple thing. Starting at the end of 1984, customers were sent forms asking them to provide a missing identification number or correct the one on file. If the number was correct, they could do nothing, unless their account was opened after Jan. 1, 1984, when the law took effect. In that case (and this is rarely understood), they had to sign a “certification” of its correctness and of the fact that they weren’t for any reason “subject to backup withholding”--a certification that most institutions now ask customers to sign when opening an account.

The forms themselves seem incomprehensible, starting with the definition of “backup withholding”--”really just a punitive withholding to be sure people pay the tax,” says Giannangeli. But on W-9s it is either not defined at all or only semi-defined as the legal requirement that payers “withhold and pay to IRS 20% of payments of interest dividends, and certain other payments under certain conditions. This is called ‘backup withholding.’ ”

Whatever it is, consumers have to certify that they’re “not subject” to it. That is defined by their being categorized “exempt” (a list ranging from foreign governments to futures commissions merchants) or by their not filling the criteria for being “subject” (gave the wrong identifying number, or none, were “notified” that they were subject, were guilty at some point of a certification failure).

Difficult to Understand

“First you wonder ‘Does this say what I think it does?’ ” says a Los Angeles housewife, “then you realize that, whatever it says, it’s poorly worded, like those ballot propositions that say ‘Vote yes if you don’t think so.’ ” “It’s like most tax forms,” says a Boston woman, “full of odd negatives, backwards definitions and circular instructions.” (Example: “If after being notified by IRS that you were subject to backup withholding you received another notification from IRS that you are no longer subject to backup withholding, do not cross out item (2).”)

Even financial institutions may not understand. Branch officers often explain poorly. Headquarters may send out repeat forms to people already checked and certified. Others require signed certifications from every one--perhaps just in case they misunderstood the rules.

After all the hullabaloo, the program’s effect is unknown, and apparently will remain so for some time. Banks complain that it’s expensive, but may also “agree with the purpose, which is to tighten down on the abuses of non-reporting,” says Frank Sperling, vice president at Security Pacific National Bank.

Except for the confusion, consumers don’t object to it as they did to mandatory withholding, which would have been a hardship for anyone on a tight income. Now, says a bank executive, “nobody’s getting hurt but the person who earned interest and doesn’t want to pay on it”--a relatively small number, says the American Bankers Assn., which estimates that fewer than 10% of all accounts at banks are under backup withholding.

One might ask what the IRS is getting from all this toward closing the tax gap, and how much of that missing $7.7 billion they’re taking in. But no one will know for some time: The IRS accounting for 1984 is not due until almost 1986.