Backup Withholding

AAA

DEFINITION of '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.

BREAKING DOWN 'Backup Withholding'

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 TERMS
  1. Withholding Allowance

    An allowance an individual claims on a W-4 Form. A withholding ...
  2. W-4 Form

    A form completed by an employee to indicate his or her tax situation ...
  3. Income Tax

    A tax that governments impose on financial income generated by ...
  4. Withholding

    The portion of an employee's wages that is not included in his ...
  5. Canada Revenue Agency - CRA

    A federal agency that collects taxes and administers tax laws ...
  6. Withholding Tax

    1. Income tax withheld from employees' wages and paid directly ...
Related Articles
  1. Taxes

    Tax-Saving Advice For IRA Holders

    Be informed about benefits and deductions that may apply to you and avoid costly mistakes on your return.
  2. Retirement

    Avoiding Too Much Tax On Your Distributions

    IRA assets can't be taxed twice - find out how to avoid paying the second time around.
  3. Taxes

    Understanding The U.S. Tax Withholding System

    Understanding the origins of our tax withholding system is crucial to getting the most out of it.
  4. Taxes

    3 Common Tax Questions Answered

    We clarify some rules that often puzzle taxpayers.
  5. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  6. Professionals

    The Rich Get Richer: Global Wealth is Rising

    Global wealth is rising and expected to continue. Advisors should know that the wealthy value fee transparency, performance.
  7. Taxes

    What's Wrong with the American Tax System

    American's are highly taxed and we still run a deficit. We explain why.
  8. Investing News

    How 'Honesty' Could Pay off for Jessica Alba

    Is it possible that Jessica Alba is one of the savviest businesswomen on the planet?
  9. Retirement

    Top Tips for Minimizing Taxes on Social Security

    Social Security benefits are taxable under certain circumstances. Here are some ways retirees can lessen the tax burden.
  10. Term

    What is Wealth Management?

    Wealth management combines financial and investment advice, accounting and tax services, and legal and estate planning.
RELATED FAQS
  1. Are spousal Social Security benefits taxable?

    Your spousal Social Security benefits may be taxable, depending on your total household income for the year. About one-third ... Read Full Answer >>
  2. How are non-qualified variable annuities taxed?

    Non-qualified variable annuities are tax-deferred investment vehicles with a unique tax structure. After-tax money is deposited ... Read Full Answer >>
  3. How do you calculate penalties on an IRA or Roth IRA early withdrawal?

    With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the ... Read Full Answer >>
  4. Are credit card rewards taxable?

    Credit card rewards are taxable in the United States some of the time. The Internal Revenue Service (IRS) classifies credit ... Read Full Answer >>
  5. How is Social Security tax calculated?

    The Old-Age, Survivors and Disability Insurance program, or OASDI, tax is calculated by taking a set percentage of your income ... Read Full Answer >>
  6. Are Social Security benefits taxable after age 62?

    Eligibility to collect Social Security benefits begins at age 62. Many seniors, to collect larger benefit amounts, wait until ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Alligator Spread

    An unprofitable spread that occurs as a result of large commissions charged on the transaction, regardless of favorable market ...
  2. Tiger Cub Economies

    The four Southeast Asian economies of Indonesia, Malaysia, the Philippines and Thailand. Tiger cub economy indicates that ...
  3. Gorilla

    A company that dominates an industry without having a complete monopoly. A gorilla firm has large control of the pricing ...
  4. Elephants

    Slang for large institutions that have the funds to make high volumes trades. Due to the large volumes of stock that elephants ...
  5. Widow's Exemption

    In general terms, a widow's exemption refers to the amount that can be deducted from taxable income by a widow, thereby reducing ...
  6. Wedding Warrant

    A warrant that can only be exercised if the host asset, typically a bond or preferred stock, is surrendered. Until the call ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!