Backup withholding is a term used to refer to the regular withdrawal of money from any investments or investment income one has in order to fulfill their tax obligations. The Internal Revenue Service (IRS) enforces this practice to ensure that individuals and entities contribute to the U.S. tax system by setting aside a portion of their income and submitting it to the IRS as payment for taxes.

When an an investor has not provided a correct taxpayer identification number (TIN), has underreported certain types of income, or has failed to pay taxes on reported income, then the IRS can mandate that a certain percentage of their income be sent as an additional payment in order to satisfy their tax obligation. This percentage is referred to as backup withholding and is equal to 24%. In some cases, the IRS may order that taxes be withheld from payments of interest income, dividend income, and rent income.

It is important to note that backup withholding is not applicable to all payments received. Payments received as part of retirement benefits or unemployment compensation are exempt from backup withholding.

If an investor is affected by backup withholding, they must file an income tax return to receive credit for the amount withheld. In the event that too much taxes were withheld, the investor can expect to receive a refund. They should also review their eligibility for tax credits they may be eligible for.

Backup withholding is an important tool used by the IRS to monitor individual and entities income and ensure they are paying the appropriate taxes in a timely manner. To ensure that no income is subject to backup withholding, investors should ensure that their taxpayer identification number is up-to-date, accurately report all income on their tax return, and make any necessary payments on or before their due date.