Backup Withholding on Third Party Network Transactions

IRS Implements OBBBA: Backup Withholding Thresholds Revert

The IRS is updating backup withholding regulations to align with the 'One, Big, Beautiful Bill Act' (OBBBA) of 2025. This follows a period of uncertainty created by the American Rescue Plan Act (ARPA). The ARPA had amended Section 6050W, which requires payment settlement entities, including Third Party Settlement Organizations (TPSOs) like Venmo and PayPal, to report payments made to participating payees, lowering the reporting threshold to $600.

However, Section 70432 of the OBBBA retroactively reverted this change to the pre-ARPA standard. Now, TPSOs are only required to file information returns if payments to a payee exceed $20,000 and involve more than 200 transactions in a calendar year.

This is especially important because these thresholds now govern when TPSOs must 'backup withhold' tax under Section 3406 if a user fails to provide a Taxpayer Identification Number (TIN) or if the IRS notifies the TPSO that the TIN is incorrect. The OBBBA added a new paragraph (8) to Section 3406(b), ensuring that backup withholding requirements are aligned with the 6050W reporting thresholds for TPSOs. In simpler terms, backup withholding now only applies if the payments also meet the $20,000/200 transaction requirements.

The retroactive effective date is July 4, 2025, as if included in the ARPA. These regulations apply for calendar years after December 31, 2024.

The New Math: $20,000 and 200 Transactions

As we discussed, the OBBBA added a new paragraph (8) to Section 3406(b), ensuring that backup withholding requirements are aligned with the 6050W reporting thresholds for TPSOs. In simpler terms, backup withholding now only applies if the payments also meet the $20,000/200 transaction requirements.

The retroactive effective date is July 4, 2025, as if included in the ARPA. These regulations apply for calendar years after December 31, 2024.

Under Section 3406, which mandates backup withholding on "reportable payments" under certain conditions (e.g., failure to provide a Taxpayer Identification Number), a payment is only treated as a 'reportable payment' if it also meets the de minimis requirements of Section 6050W. Section 6050W governs information returns for payments made through third-party settlement organizations (TPSOs) like PayPal or Venmo. These organizations must report payments to the IRS on Form 1099-K, Payment Card and Third Party Network Transactions.

Therefore, for a TPSO payment to trigger backup withholding under Section 3406, both of the following conditions must be met during the calendar year:

• The aggregate number of transactions with respect to the participating payee exceeds 200, and
• The aggregate dollar amount of transactions with respect to the participating payee exceeds $20,000.

A critical component of the new regulations involves the "catch-up" mechanic. Withholding applies to the entire amount of the transaction that pushes the payee over either the 200 transaction limit or the $20,000 threshold, whichever condition is met later, and to all subsequent transactions during the remainder of the calendar year.

For example, imagine a gig worker receives 199 payments through a TPSO, totaling $19,500 by late November.

• The 200th transaction in December is for $600. This final transaction causes the payee to exceed the 200-transaction limit, though the aggregate dollar amount is still below $20,000. Because the 200-transaction limit was triggered first, the entire $600 payment is subject to backup withholding. All subsequent payments made in December are also subject to backup withholding, regardless of their individual amounts, until the end of the year.

Now, let's assume that the gig worker receives a payment of $1,000 as transaction number 150. This payment pushes the aggregate dollar amount over $20,000, while the number of transactions is still below 200. The entire $1,000 payment, and all subsequent payments made during the year, is subject to backup withholding.

In summary, TPSOs must track both the number of transactions and the aggregate dollar amount paid to each payee. Once both thresholds are surpassed, backup withholding is triggered for the entire amount of the triggering transaction and all subsequent transactions during the year.

The 'Look-Back' Trap: Once Reportable, Always Suspect?

As we discussed, Section 3406 of the Internal Revenue Code mandates backup withholding under certain conditions, primarily when a payee fails to furnish a Taxpayer Identification Number (TIN). With the OBBBA aligning the backup withholding rules with the new Section 6050W reporting thresholds ($20,000 and 200 transactions), one might assume that small-volume sellers are entirely shielded from withholding if they don't provide a TIN.

However, the IRS has included a critical exception to this general rule. The proposed regulations clarify that the de minimis exception under Section 6050W(e) does not apply to payments made to a payee in a given calendar year if payments made to that payee in the preceding calendar year were "reportable payments." In other words, if a payee's transactions exceeded the $20,000/200 threshold in 2026, they are subject to backup withholding on every payment received in 2027 if they have not provided a TIN, regardless of whether they meet the thresholds in 2027. This creates a "look-back" effect, impacting compliance significantly.

Consider these examples:

• Example 2: Platform A, a Third-Party Settlement Organization (TPSO), made 201 payments totaling $20,000.01 to payee Y in 2026. Because these payments exceeded both the transaction and dollar thresholds, they were reportable under Section 6050W. In 2027, A makes only 199 payments to Y, totaling $18,000. Even though Y does not meet the de minimis thresholds in 2027, A must backup withhold on each payment made to Y in 2027 because payments made to Y in 2026 were reportable.

• Example 3: Continuing from the previous example, in 2028, A makes only four payments to Y totaling $2,000. Again, because payments made to Y in the preceding year (2027) were subject to backup withholding (due to 2026 being a reportable year), A must continue to backup withhold on each payment made to Y in 2028.

This "look-back" provision means that once a payee crosses the reporting threshold, they remain subject to backup withholding in subsequent years until they provide a valid TIN, regardless of their transaction volume or dollar amount in those subsequent years. This provision particularly affects gig economy workers and online sellers, who may experience fluctuating income levels year to year, but could still get ensnared by this rule if they do not furnish a TIN to the TPSO.

Impact: Winners, Losers, and Dates

As a result of the OBBBA and these proposed regulations, the landscape of TPSO reporting and backup withholding has shifted, creating winners and losers. Those who benefit most are casual sellers who fall below the $20,000 and 200-transaction threshold outlined in Section 6050W, which governs information reporting requirements for Third-Party Settlement Organizations (TPSOs). Because Section 3406, which mandates backup withholding when a payee fails to furnish a Taxpayer Identification Number (TIN), is now aligned with Section 6050W, these casual sellers will avoid unexpected withholding.

Conversely, the "look-back" provision may ensnare repeat, high-volume sellers. Even if a seller's activity dips below the $20,000/200-transaction mark in a subsequent year, they could still be subject to backup withholding under Section 3406 if they triggered the reporting threshold in a prior year and failed to provide a valid TIN to the TPSO.

These regulations are proposed to apply to payments made in calendar years beginning after December 31, 2024. Therefore, Notices 2023–10, 2023–74, and 2024–85 are now obsolete as of January 9, 2026, as they are inconsistent with the statutory revisions brought about by the OBBBA.

The IRS asserts in its Regulatory Flexibility Act analysis that these proposed regulations will not have a significant economic impact on a substantial number of small entities. The reasoning is that while the rule affects entities required to file information returns, the increase in the threshold to trigger backup withholding actually reduces the frequency with which these entities must withhold, compared to the stricter rules initially implemented by the American Rescue Plan Act (ARPA).