Proposed Regulations provide relief on backup withholding for online marketplaces

The IRS recently issued proposed regulations (REG-112829-25) (Proposed Regulations) under section 3406 of the Internal Revenue Code of 1986, as amended (Code), relating to backup withholding requirements with respect to payments made in settlement of third party network transactions under section 6050W.

As discussed more fully below, the proposed regulations would update existing regulations to reflect statutory changes to section 3406 that were enacted as part of the One Big Beautiful Bill Act (OBBBA).

Section 3406 generally requires a payor to backup withhold with respect to an “other reportable payment” if the payee does not provide a valid taxpayer identification number (TIN). As relevant a payment required to be reported under section 6050W is an “other reportable payment.”

Third party settlement organizations (TPSOs) are required under section 6050W to report on Form 1099-K payments made in settlement of transactions on their networks. Section 6050W(e), as amended by OBBBA provides a de minimis exception under which a TSPO is not required to file information returns if payments to a payee do not exceed $20,000 and 200 transactions in a calendar year (De Minimis Threshold). Prior to amendment by OBBBA, the De Minimis Threshold had been reduced by the American Rescue Plan Act of 2021 to $600 in a calendar year, regardless of the number of transactions. The OBBBA amendments reverted the De Minimis Threshold to its original amount (i.e., $20,000 and 200 transactions).

OBBBA also amended section 3406 to align with the De Minimis Threshold, such that a payment by a TSPO in settlement of a third party network transaction under section 6050W is treated as a reportable payment for purposes of section 3406 only if the payments to the payee exceed $20,000 and 200 transactions in a calendar year. Prior to the amendment, section 3406 (and the section 3406 regulations) required backup withholding regardless of whether the De Minimis Threshold had been met. The Proposed Regulations would amend the section 3406 regulations to be consistent with the OBBBA amendment.

The Proposed Regulations provide that whether a payment made in settlement of a third party network transaction is treated as a “other reportable payment” for purposes of section 3406 is determined by considering the De Minimis Threshold. If the De Minimis Threshold is exceeded, the amount subject to withholding under section 3406 is the total amount of the transaction that either causes the total number of transactions to exceed 200 or the aggregate amount of payments made to the payee in third party settlement transactions to exceed $20,000. In other words, exceeding the De Minimis Threshold would not cause all prior transactions to be subject to backup withholding.

Eversheds Sutherland Observation: If finalized, the Proposed Regulations would reduce the compliance burden for TSPOs with respect to payees that fall below the De Minimis Threshold, as a TIN would no longer need to be obtained at account opening to prevent the application of backup withholding by the TSPO. Prior to the 2021 amendments to section 6050W, many TPSOs primarily serving casual or occasional sellers would not solicit the TIN until the payee was close to $20,000 or 200 transactions. After the 2021 amendments, TPSOs shifted to soliciting the TIN at accounting opening.

The amendments to section 3406 and the section 3406 proposed regulations only apply to reporting under section 6050W for TPSOs. Section 6050W also requires reporting of payment card transactions, but the reporting and backup withholding requirements applicable those transactions are unaffected. There is no de minimis threshold applicable to payment card transactions.

The Proposed Regulations also contain an exception under which all payments to a payee in settlement of a third party network transaction are treated as reportable payments if any payment to the payee in the preceding year was a reportable payment.

Eversheds Sutherland Observation: As a result of this exception, once the de minimis exception is exceeded with respect to a payee, unless the payee provides a TIN, all future payments to the payee in settlement of third party network transactions would be reportable payments that are possibly subject to backup withholding until there is a year in which no payments are made by the TSPO to the payee in settlement of third party network transactions. Consequently, amounts that constituted payments under the prior $600 threshold may continue to be treated as reportable payments going forward, unless the payee provides a TIN. In addition, this may result in disparate treatment of a payment under sections 6050W and section 3406. For example, an amount may not be reportable under section 6050W but nonetheless be treated as a reportable payment under section 3406. This differing treatment may require TSPOs to update their internal compliance systems to ensure effective monitoring and compliance.

The Proposed Regulations are proposed to be retroactive and would apply with respect to calendar years beginning after December 31, 2024.

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