Backup Withholding

Halloran Securities is opening a brokerage account for Anneke Vos, a Dutch citizen residing in Amsterdam who is not a U.S. taxpayer. She intends to hold dividend-paying U.S. common stocks. Which form should the firm obtain from her, and what does it accomplish?

1. A.Form W-8BEN, which certifies her foreign status and lets her claim any reduced treaty rate of U.S. withholding on her dividends.Correct. The W-8BEN establishes non-U.S. status and supports a treaty claim for a reduced withholding rate.
2. B.Form W-8BEN, which exempts her entirely from U.S. withholding tax on dividends paid by U.S. issuers.Right form, wrong effect. A treaty claim generally REDUCES the withholding rate on dividends; it does not eliminate withholding.
3. C.No form is required, because a nonresident alien falls outside U.S. withholding rules altogether.Wrong. U.S.-source dividends paid to nonresident aliens are subject to withholding, which is precisely why the certification matters.
4. D.Form W-9, which certifies her taxpayer identification number and exempts her from backup withholding.Wrong. Form W-9 is for U.S. persons. A nonresident alien certifies status on a W-8 series form.

Why: A nonresident alien beneficial owner certifies her foreign status on Form W-8BEN. The form does two things: it establishes that she is not a U.S. person, so U.S. backup withholding and Form 1099 reporting do not apply, and it lets her claim any reduced rate of withholding available under the income tax treaty between the United States and her country of residence. It does not eliminate withholding. Absent a treaty claim, U.S.-source dividends paid to a nonresident alien are subject to a statutory withholding rate, and a valid treaty claim typically reduces rather than removes it.

A new customer at Calderwood Brokerage opened her account without certifying her taxpayer identification number, and the certification is still outstanding when the account receives its first dividend. The IRS has sent the firm no notice about this customer. What must the operations department do with the payment?

1. A.Pay the dividend in full and restrict the account until the certification arrives.Wrong. Restricting an account is a firm remedy and does nothing about a payment the tax rules already reach.
2. B.Withhold only if the IRS notifies the firm that the number on file is incorrect.Wrong. That is one trigger among several, and it is not the one these facts turn on.
3. C.Apply backup withholding to the payment and remit it until a certified number is on file.Correct. A missing certification is an independent trigger, whatever the IRS has or has not sent.
4. D.Withhold nothing, because backup withholding reaches sale proceeds rather than dividend payments.Wrong. Dividends sit squarely within the payments the regime covers.

Why: Backup withholding is required where a payee has not furnished a correct taxpayer identification number certified on the prescribed form, and separately where the IRS notifies the payer that the number on file is wrong or that the payee has underreported interest and dividends. Those are independent triggers, so the absence of an IRS notice does not remove the duty created by a missing certification. The firm withholds at the required rate from the reportable payment and remits it, stopping once a correctly certified number is on file. Restricting the account instead is a firm-imposed remedy that the tax rules neither require nor accept as a substitute.

Perpetua redeems 12,000 dollars of Ashworth Balanced Fund shares. She never returned the Form W-9 the fund mailed her, her taxpayer identification number has therefore never been certified, and the fund has been instructed to apply backup withholding at a rate of 24%. Ignoring any redemption fee, what does the transfer agent do with her proceeds?

1. A.It pays the full 12,000 dollars and simply reports the gross proceeds on Form 1099-B, leaving any tax to Perpetua.Reporting alone is what happens when the number IS certified. An uncertified number is exactly what triggers withholding.
2. B.It withholds 2,880 dollars, remits that amount to the IRS, and pays Perpetua 9,120 dollars.Correct. The 24% rate is applied to the full 12,000 dollar reportable payment.
3. C.It withholds 2,880 dollars only from the portion of the proceeds representing gain and pays her the rest of the redemption in full.The withholding agent does not compute her gain. The rate is applied to the gross payment.
4. D.It refuses to process the redemption until a certified Form W-9 is on file.A fund may not block a shareholder redemption over a missing W-9. It processes the trade and withholds instead.

Why: Backup withholding applies to the gross reportable payment, not to the profit inside it. The transfer agent withholds 24% of 12,000 dollars, or 2,880 dollars, remits that to the IRS, and pays Perpetua the remaining 9,120 dollars. The redemption itself is still processed and reported on Form 1099-B; withholding is a prepayment of tax that Perpetua can claim as a credit on her return once she certifies her number.

Anselmo is a nonresident alien with a valid certification of foreign status on file and no treaty benefit claimed. Assume the statutory withholding rate on United States source dividends paid to such a person is 30 percent. During the year Ravelston Equity Fund pays him a 4,000 dollar ordinary income dividend, and he also redeems shares for 25,000 dollars. With respect to United States withholding, the fund should:

1. A.Withhold 30 percent from both the dividend and the redemption proceeds, because Anselmo is a nonresident alien.Withholding follows the character of the payment. Redemption proceeds are not dividends and are generally not subject to this withholding.
2. B.Withhold nothing from either payment, because Anselmo has certified his foreign status.Certifying foreign status establishes which regime applies; it does not exempt United States source dividends from withholding.
3. C.Withhold 30 percent from the 4,000 dollar dividend and nothing from the 25,000 dollar redemption.Correct. The dividend is United States source income subject to the statutory rate, while gross redemption proceeds are generally not subject to withholding.
4. D.Withhold 30 percent from the redemption proceeds only, because the dividend was automatically reinvested.Nothing in the facts says the dividend was reinvested, and reinvestment would not avoid withholding on a taxable dividend in any event.

Why: Ordinary income dividends paid by a United States fund to a nonresident alien are United States source income subject to withholding at the statutory rate unless a treaty reduces it, so 30 percent of the 4,000 dollar dividend is withheld. Redemption proceeds are not a dividend; they are payment for the sale of a capital asset, and a nonresident alien is generally not subject to United States withholding on the gross proceeds of the redemption.