Understanding Withholding Tax: An Essential Overview
Withholding tax refers to the portion of an employee’s wages that an employer deducts and sends directly to the government as a credit against income taxes that the employee owes for the year.
The vast majority of workers in the United States, as well as nonresident aliens earning income from U.S. sources, are subject to withholding tax.
Key Takeaways
- Withholding tax is the portion of income tax that an employer withholds from an employee’s paycheck.
- Employers remit withheld taxes directly to the IRS in the employee’s name.
- Withholding tax acts as a credit against the employee’s annual income tax bill.
- Employees may receive a tax refund if too much is withheld or owe extra if too little is deducted.
- Both U.S. residents and nonresidents are subject to withholding on income earned within the U.S.
A Deep Dive into Withholding Tax
Withholding tax facilitates a pay-as-you-go income tax system, ensuring that tax collection is maintained at the source of income rather than post-earning. Whenever an employee gets paid, their employer withholds a percentage as income tax, paid by the employer to the IRS.
The withheld amount appears on the employee’s pay stub and is summarized annually on Form W-2. Employers send W-2 forms to employees to aid in filing annual tax returns.
Factors Affecting Withholding Tax
- Amount earned
- Filing status
- Withholding allowances
- Additional income withholding requests
To ensure proper withholding, employees should verify their tax details early in the year and after any significant changes in their financial situation or tax status.
Special Considerations
Most U.S. states also operate tax withholding systems with help from the IRS W-4 Form, although nine states do not impose income tax.
States With No Income Tax:
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
History of Withholding Tax
First introduced by President Abraham Lincoln in 1862 to finance the Civil War, withholding tax and income tax were abolished in 1872 and reimplemented during a tax hike in 1943. This system ensures tax funds are collected directly from wages.
Federal withholding tax is one type of payroll tax, the other being taxes paid by employers based on employee wages, funding Social Security, Medicare, and federal unemployment programs.
Types of Withholding Taxes
U.S. Resident Withholding Tax
Withheld from U.S. residents’ personal income, this tax is directly collected by employers and paid to the government, with employees settling any remaining tax obligations when filing their returns.
Independent contractors and investors, however, pay quarterly estimated tax and might face backup withholding if they fall behind on payments.
Nonresident Withholding Tax
Nonresident aliens are taxed on U.S.-sourced income with the help of standard IRS tables. Tax treaties between countries may affect the withholding process. Form 1040NR is used for filing.
Calculating Your Withholding Tax
Withholding applies at various federal tax rates based on income. The rates for 2024 are outlined in the table below:
| Tax Rate | Income Range (Single, Married Filing Separately) | Income Range (Married Filing Jointly) |
|---|---|---|
| 10% | $11,600 or less | $23,200 or less |
| 12% | $11,601 to $47,150 | $23,201 to $94,300 |
| 22% | $47,151 to $100,525 | $94,301 to $201,050 |
| 24% | $100,526 to $191,950 | $201,051 to $383,900 |
| 32% | $191,951 to $243,725 | $383,901 to $487,450 |
| 35% | $243,726 to $609,350 | $487,451 to $731,200 |
| 37% | More than $609,350 | More than $731,200 |
Use the IRS Withholding Estimator for accurate calculation. You will need your filing status, income source, additional income, and recent pay stubs.
Purpose and Adjustment of Withholding Tax
Withholding ensures the timely payment of income taxes, preventing huge tax bills at year-end. Adjust your withholding amount as needed to match your tax liability better.
Employer’s Withholding Mistakes
An incorrect W-4 form results in too much or too little withholding. Keep this form updated with accurate information.
Exemptions from Withholding
Employees with zero tax liabilities can use Form W-4 to request exemption for a calendar year.
Final Thoughts
Withholding tax directly affects your paycheck and annual tax invoice. Adjust fill-up of your W-4 to manage your withholding amounts effectively and avoid surprises during tax time.
Related Terms: income tax, payroll tax, tax return, estimated tax, nonresident alien.
References
- Internal Revenue Service. “Tax Withholding: How to Get it Right”.
- Tax Foundation. “State Individual Income Tax Rates and Brackets, 2024”.
- New Hampshire Department of Revenue Administration. “Frequently Asked Questions - Interest & Dividend Tax”.
- New Hampshire Department of Revenue. “Taxpayer Assistance - Overview of New Hampshire Taxes”.
- Internal Revenue Service. “Historical Highlights of the IRS”.
- Library of Congress. “Income Tax Day”.
- Internal Revenue Service. “About Form W-4, Employee’s Withholding Certificate”.
- Centers for Medicare & Medicaid Service. “Milestones 1937 to 2015”, Page 2.
- Social Security Administration. “Social Security Act of 1935”.
- Internal Revenue Service. “Topic No. 751, Social Security and Medicare Withholding Rates”.
- Internal Revenue Service. “Tax Withholding for Individuals”.
- Internal Revenue Service. “Topic No. 306, Penalty for Underpayment of Estimated Tax”.
- Internal Revenue Service. “Estimated Taxes”.
- Internal Revenue Service. “Topic No. 307, Backup Withholding”.
- Internal Revenue Service. “Tax Withholding Estimator”.
- Internal Revenue Service. “NRA Withholding”.
- Internal Revenue Service. “Nonresident Aliens”.
- Internal Revenue Service. “Taxation of Nonresident Aliens”.
- Internal Revenue Service. “Nonresident — Figuring Your Tax”.
- Internal Revenue Service. “Publication 519: U.S. Tax Guide for Aliens”, Page 42.
- Internal Revenue Service. “26 CFR 601.602: Tax Forms and Instructions”.
- Internal Revenue Service. “Topic No. 753, Form W-4 – Employee’s Withholding Certificate”.
