Backup withholding is a fixed-rate tax that is applied to investment income. The tax is levied by the financial intermediary at the point when an investor realizes the investment income. This withholding is conducted to ensure that the government receives its due share of the investment income, rather than running the risk of having an investor not have the cash available for payment when income taxes are normally due.
When backup withholding occurs, it is immediately forwarded to the applicable government entity. The investor can then claim this advance payment when filing a tax return, as a credit against the tax payable.
Backup withholding is also applied when an individual or entity has not reported a valid taxpayer identification number (TIN) via a Form W-9 to an entity that is paying the individual or entity. If the payer finds that the TIN is invalid, the payer sends a "B" notice to the individual or entity. A corrected TIN should be sent to the payer at once, to prevent backup withholding from commencing.
The backup withholding rules do not apply to wage or pension payments.