Backup withholding is a practice of automatically deducting money from an investor’s payout. The backup withholding helps ensure your payments are accurate and complete, protects you from future tax consequences, and improves compliance and taxes. There is a backup withholding on the income you received from stocks and bonds. So, when you sell shares or bonds, the payer usually withholds a portion of the proceeds to pay your income tax.
Backup withholding generally applies to certain distributions from a corporation or other entity not considered responsible for collecting the taxes, e.g., mutual funds, trusts, and estates. Several factors are used in determining whether or not backup withholding will apply, including the type of fund or security and the type of income earned.