Withholding is the portion of an employee’s wages that is not included in their paycheck but is instead remitted directly to federal tax authorities and, where applicable, state and local tax authorities.
The employee’s income, marital status, number of dependents, and number of jobs all determine the amount withheld. These details are recorded by the employee on a W-4 form supplied by the employer.
Withholding is an estimate of the taxes the employee will owe. American taxpayers file an annual tax return to record their actual income from all sources for the full year and the amount they have already paid. This, along with any deductions they claim, determines what they actually owe for the year and could result in either an additional payment or a refund of overpaid taxes.
Key Takeaways
- Withholding serves as an installment payment on the tax that an employee will owe for the full year.
- Form W-4 gathers information such as marital status and number of dependents to help employers determine the amount to withhold.
- Insufficient withholding could result in the employee owing money at the end of the year.
- Social Security and Medicare taxes, along with income taxes, are automatically withheld from employees’ wages.
- State withholding rates vary, and nine states have no income tax.
- Seventeen states allow local governments to levy income tax on residents.
A Deep Dive into Tax Withholding
In the United States, all income earners are obligated to pay income tax to the federal government. Most states have income taxes as well, and a few counties and cities levy resident income taxes.
Employers are required to withhold tax from employees’ paychecks to ensure that they consistently pay their income taxes. Employers remit the tax collected to the Internal Revenue Service (IRS) on behalf of the wage earners.
Form W-4
An employee who starts a new job must fill out IRS Form W-4, which the employer typically provides. For example, the employee must indicate whether they have one or multiple jobs. If they have multiple jobs, they must disclose how much is earned from the other job(s).
The employee is also expected to disclose their marital status. If married, they should indicate whether the spouse is employed and how much the spouse earns.
Form W-4 also includes questions about dependents and filing status, such as being head of household or married filing jointly. The employer uses the information provided by the employee to calculate the amount of tax to withhold from the employee’s pay.
A new life event, such as a change in marital status, an additional dependent, or a new job, requires the employee to submit a new W-4. The employer uses this new information to re-evaluate the portion of income to withhold for tax purposes.
Special Considerations
If the tax withheld is inaccurate, the taxpayer has to pay more or less when tax filing season arrives. If the employee paid too much, the IRS will refund the excess. Workers who did not pay enough tax on earned income may be subject to late-payment penalties and interest.
Self-employed workers aren’t subject to withholding but must pay their income taxes, usually as quarterly estimated tax payments. Taxpayers may also need to make estimated tax payments if they receive substantial income as dividends, capital gains, interest, or royalties.
Federal Withholding vs. State Withholding
Withholding is generally classified as federal withholding or state withholding.
Federal withholding is the amount withheld from wages for taxes owed to the federal government. The amount of withholding is based on filing status, the number of dependents, certain adjustments to income, and other personal withholding preferences selected on Form W-4.
Wage-earners can elect to have a specific amount withheld in addition to what’s calculated from elections. They can also elect to have nothing withheld by claiming an exemption. Federal withholding includes amounts paid into the Social Security and Medicare funds. From the employees’ pay, 6.2% is withheld for Social Security and 1.45% for Medicare.
State withholding is the amount withheld from wages for taxes owed to the taxpayer’s state of residence. In some cases, the taxpayer may owe taxes to multiple states. For instance, if a remote worker divides their time between two residences in different states, they may owe taxes to each state, and it may be possible for an employer to withhold taxes for each state.
Other Types of Withholding
Employees who have retirement accounts through their employers have their contributions withheld from their paychecks. Employees with traditional retirement accounts rather than Roth accounts do not pay income tax on their contributions. They are paying in “pre-tax” dollars and will owe income taxes on that money only when they withdraw it. That reduces their income for the year and the amount of tax withheld from their paychecks.
Employees with Roth accounts pay the income taxes on their contributions up front. That is, they pay taxes on their full income but contribute a portion to the retirement account. They should owe no further taxes on that money when they withdraw it.
What Does It Mean to Withhold Taxes?
To withhold taxes is to deduct a portion of an employee’s wages for taxes and remit it immediately to the government. This is an estimate of the amount that the employee will owe for that period.
How Much Withholding Should I Claim?
The amount you should withhold is based on your personal circumstances. It depends on your income, whether you have dependents, if you have additional sources of income, and more. A single person with one job and no dependents would generally select a single filing status with one allowance. A married couple with dependents would usually select married filing jointly with several allowances.
Should I Claim 0 or 1 on My Withholding?
Electing 0 as an allowance on the W-4 for tax withholding will result in the largest amount being withheld for your filing status. Claiming one allowance will reduce what is withheld for taxes but may still be sufficient for what is owed. Claiming 0 is preferred by people who can be claimed as dependents by others and by people who have more than one source of income.
Is It Better to Have Taxes Withheld From Unemployment?
The IRS recommends withholding taxes from unemployment wages to avoid owing the full amount due on the tax deadline.
What Is the Withholding Compliance Program?
The IRS’s Withholding Compliance Program identifies taxpayers whose payroll deductions appear to be in error to help them remedy the deficiency.
The Bottom Line
Withholding is the amount deducted from wages for taxes: federal, state, or local. All wage-earners in the U.S. have federal taxes withheld. Most have state taxes withheld, and some have local taxes to pay as well.
If more than enough taxes are withheld throughout the year, the taxpayer will receive a tax refund after filing an annual tax return. If withholding is insufficient, the taxpayer is obligated to pay the remaining tax obligation.
Employees must complete a form W-4 to indicate what should be withheld for taxes based on their personal situation. The IRS provides a tax withholding estimator that taxpayers can use to estimate how much they should withhold.
References
- Internal Revenue Service. “Tax Withholding”.
- Internal Revenue Service. “Topic No. 753, Form W-4 – Employee’s Withholding Certificate”.
- City of St. Louis. “US Cities That Levy Income (Earnings) Taxes”.
- Cornell University, Legal Information Institute. “Income Tax”.
- Internal Revenue Service. “Tax withholding: How to get it right”.
- Internal Revenue Service. “Form W-4”. Pages 1,3.
- Internal Revenue Service. “Form W-4”. Page 1.
- Internal Revenue Service. “Form W-4”.
- Internal Revenue Service. “Publication 505, Tax Withholding and Estimated Tax”.
- Internal Revenue Service. “Topic No. 751 Social Security and Medicare Withholding Rates”.
- Internal Revenue Service. “Publication 590-A (2022), Contributions to Individual Retirement Arrangements (IRAs)”.
- Internal Revenue Service. “Traditional and Roth IRAs”.
- Internal Revenue Service. “People Should Have Tax Withheld From Unemployment Now to Avoid a Tax-Time Surprise”.
- Internal Revenue Service. “Chapter 19. Liability Collection”.
