Back-up withholding

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Back-Up Withholding

The garnishment of both regular income and investments for tax purposes. In most developed countries, a certain percentage of wages and salaries are withheld from the employee and paid directly to the tax authority. The same applies with many investment profits, including, but not limited to, dividends, commissions, and fees. It does not generally apply to real estate transactions. Governments instituted this regulation to avoid the possibility that a taxpayer may spend all his/her money before it is due to the tax authority, leaving it with the difficult process of collecting. In the United States, back-up withholding originated before the Civil War and was reinstituted in the 1940s.
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Back-up withholding.

Back-up withholding is triggered when a bank, brokerage firm, or other institution pays interest, dividends, or other income that must be reported on IRS Form 1099 to a payee who does not provide a tax identification number (TIN), typically a Social Security number, or provides an incorrect number.

While income that's reported on Form 1099 is not normally subject to withholding, in this instance, the payer must withhold 28% of the gross amount as income tax.

You can avoid back-up withholding in most cases by providing a correct TIN using IRS form W-9. But if the IRS determines you have underreported your investment income, it may require back-up withholding even if the payer has your TIN.

Dictionary of Financial Terms. Copyright © 2008 Lightbulb Press, Inc. All Rights Reserved.