Taxes: What Is an Exempt Payee?

An exempt payee is an individual, or group, that receives income for which backup withholding is not required. If you, or your group, are considered tax exempt, you will be required to complete a W-9 form, which is required by the IRS. Any business that pays an exempt payee for goods or services is required to issue this form to the IRS, along with the amount that was paid to you. To qualify for exempt payee status, there must have been no tax liabilities in the prior year and expectations to have no such tax liabilities for the current year. New institutions, such as churches, government agencies or charitable groups, or individuals with this new status, must only expect no tax liabilities for the current year.

An individual, or group, is an exempt payee when they are not subject to backup withholding. The reason backup withholdings are not required of exempt payees is because they are not, in particular situations, expected to owe taxes to the IRS. Entities also included in the exempt status are nonprofit organizations or trusts and corporations. Individuals who would not be considered exempt, yet would be required to complete a W-9 form, include freelancers and sole proprietors of a business.

Backup withholding is the tax amount normally withheld from an individual’s income by an employer. If an individual, or group, claims exempt status and completes a W-9 form, claiming that status, the employer is not required to withhold taxes. The W-9 form must be complete, with the exempt box checked, a complete and valid taxpayer's identification number and signature. There can be several reasons that the IRS will not accept the exempt status, such as federal taxes are owed, the taxpayer's identification number is incorrect and if all dividends or interest is not reported.

The W-9 form is used for tax exempt payees. The form must be completed entirely and the exempt box must be checked to be considered for exempt payee status. However, the W-9 form is used for individuals that are not exempt payees, but should not have taxes withheld. These include business sole proprietorships, freelancers, for-profit businesses and limited liability companies. These individuals or companies must pay taxes for income earned according to IRS rules for their status. Therefore, the W-9 form should not be considered only for exempt payee status.

An incomplete form or one with incorrect information will be rejected by the IRS. Further, if the form is not completed, with the exempt box checked, the employer, business or company receiving the form, must withhold taxes at a rate of 28 percent. If you do not have a TIN, or taxpayer identification number, you may request one from the IRS by completing form W-7. For individuals, or sole proprietorships, your Social Security number may be used instead of a TIN number.