Subject: Tax Code - Backup Withholding

Last-Revised: 20 Mar 1997
Contributed-By: John Schott (jschott at

Once the IRS declares you a "Bad Boy" (for having underpaid or been negligent on your tax filings in other ways) they stick you with "Backup Withholding."

What this means, essentially, is that any firm that deals with your money in taxable tranactions is required to withhold (and submit to IRS) 31% of the proceeds of ANY transaction (on the assumption that the entire amount is a taxable gain). Then, next year when you file, they have all this money of yours, and you might be able to get it back if it is in excess of your actual tax liability once they have themselves determined it is indeed excess.

So if you trade often, 31% disappears each time and soon all of your capital is held by the IRS.

I think that your time in the "penalty box" lasts for 5 years (I'm not sure) if you remain faultlessly clean and petition to have it lifted.

In short - this is not something you want to get into. By the way, there is a substantial penalty if you lie to the broker about whether you are subject to this treatment.

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