Claiming a refund for erroneous backup withholding from exempt retirement plan trusts.

What can be done when a broker or other payor has invoked backup withholding on investment earnings or sales proceeds in a tax-exempt retirement trust? Can this money be refunded, and, if so, how?

Pursuant to Sec. 3406(g) and the regulations thereunder, a tax-exempt entity (such as a retirement trust) is not subject to backup withholding. However, it is possible that a broker or payor is not aware of a trust's exempt status, that the trustee did not properly complete Form W-9, Request For Taxpayer Identification Number, or the appropriate certification, and that the payor was required to begin backup withholding.

Under these circumstances, there are two alternative methods by which the retirement trust can obtain a refund of the withheld tax. The first alternative is to use Regs. Sec. 31.6413(a)-3, under which a payor refunds the withheld tax directly to the retirement trust. To obtain the refund directly, a determination must first be made that there was erroneous backup withholding. Only an actual error by the payor (e.g., an error in flagging an account subject to withholding) will constitute erroneous backup withholding. The payor or broker may, at its discretion, treat an amount as erroneously withheld, but only if:

1. The payor or broker requires an exempt recipient to certify its exempt status and such exempt payee fails to make the required certification;

2. The payor or broker does not require certification on the recipient's exempt status, but withholds anyway; or

3. The payor or broker backup withholds after the certification of exempt stares or a taxpayer identification number is provided, but before the payor or broker is required to treat them as received under Regs. Sec. 31.3406(e)-1(b).

A direct refund by the payor or broker of erroneously withheld tax can only be made before the end of the calendar year and before the time the payor or broker furnishes a Form 1099 to the recipient. The payor must maintain as part of its record a receipt showing the date and amount of the refund and not report the withholding on Form 1099.

If the backup withholding cannot be refunded directly by the payor, a second alternative allows exempt organizations (including pensions and other retirement plans) to request a refund by filing Form 990T, Exempt Organization Business Income Tax Return. Copies of the applicable Forms 1099 showing the withholding must be attached to the claim for refund. Instructions to Form 990T indicate the appropriate lines on the form and necessary attachments needed to complete and process the refund claim.

Although a retirement plan trust is exempt from backup withholding under Sec. 3406(g), it is entirely possible that a broker or payor may erroneously impose backup withholding, especially oil newly formed retirement trusts or existing ones that change from one payor or broker to another. Practitioners should be alert to this potential problem and ensure that the appropriate forms are filed with the payor or broker to avoid the problem. If, however, there is erroneous withholding, they should be aware that procedures are in place to request and obtain a refund of these amounts.

FROM BRENDAN LOGAN, MBA, HOLTZ RUBENSTEIN & CO., LLP, MELVILLE, NY

Philip E. Moore, CPA, MBA Brown, Dakes & Wannall, P.C. DFK International Fairfax, VA