Backup Withholding
Barron's Accounting Dictionary:
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Backup Withholding
Procedure used to ensure that federal income tax is paid on earnings even though the recipient cannot be identified by a Social Security number. Banks, brokers, and other entities report nonwage earnings paid out on IRS Form 1099. When the form cannot be filed because it lacks the taxpayer's Social Security number, 20% of the interest, dividends, or fees is withheld by the payer and remitted to the federal government. For example, if interest earned on a bank account is $1,000 and there is no Social Security number on file for the account, the bank withholds $200. Financial institutions have account holders fill out a FederalW-9 form requiring the individual to certify that the Social Security numbers given are correct and that they are or are not subject to backup withholding. The information regarding interest payments is reported by the bank to the IRS for comparison with individual tax returns. Backup withholding is not an additional tax; the tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. The IRS Code Section 3406 (a)(1)(c) applies to backup withholding.
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Investopedia Financial Dictionary:
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Backup Withholding
Tax that is levied on investment income, at an established tax rate, as the investor withdraws it. Backup withholding helps to ensure that government tax-collecting agencies (such as the IRS or Canada Revenue Agency) will be able to receive income taxes owed to them from investors' earnings. Backup withholding may be applied when an investor has not met rules regarding taxpayer identification numbers (TIN). At the time the investor withdraws his or her investment income, the amount mandated by the backup withholding tax is remitted to the government, providing the tax-collecting body with the required funds immediately, but leaving the investor with less short-term cash flow.
Investopedia Says:
Investors commonly earn income - for example, interest payments, dividends, capital gains - from assets in which they have invested. While this income is taxable at the time it is received, the taxes owed on any calendar year's worth of investment income only come due once every year, during tax season.
Thus, an investor could potentially spend all of his investment income before his annual income taxes come due, leaving him unable to pay taxes, and leaving the IRS with the difficult and expensive job of collecting the taxes owed. It is primarily this risk that motivates the government to sometimes require backup withholding taxes to be levied by financial institutions at the time investment income is earned.
Related Links:
We clarify some rules that often puzzle taxpayers. 3 Common Tax Questions Answered
IRA assets can't be taxed twice - find out how to avoid paying the second time around. Avoiding Too Much Tax On Your Distributions
Be informed about benefits and deductions that may apply to you and avoid costly mistakes on your return. Tax-Saving Advice For IRA Holders
Understanding the origins of our tax withholding system is crucial to getting the most out of it. Understanding The U.S. Tax Withholding System
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Barron's Accounting Dictionary
Dictionary of Accounting Terms. Copyright © 2010 by Barron's Educational Series, Inc. All rights reserved.
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Mentioned in
Backup Withholding Rate
(insurance term)
Taxpayer Identification Number (TIN)
(in banking)
Withholding Tax
(legal term)
Withholding
(finance term)
» More