Whether you’re an employee or an employer, it’s important to understand the concept of withholding tax. Below, we’ll explaining what withholding tax is, who has to pay it, and how to calculate it.
What is withholding tax?
Withholding tax is a portion of federal income tax that an employer withholds from an employee’s paycheck. Because federal income tax is a pay-as-you-go tax, employers deduct it from employees’ wages throughout the year and send it to the Internal Revenue Service (IRS) on the employee’s behalf.
The primary purpose of withholding taxes is to help prevent tax evasion, but the system also makes it easier for people to pay on a regular basis, so they won’t owe money later on.
What type of pay is subject to withholding?
According to the IRS, there are a few types of pay subject to tax withholding:
- Regular pay and vacation pay
- Reimbursements and other expense allowances paid under a nonaccountable plan
- Pensions, bonuses, commissions, gambling winnings, and other types of income
Who is subject to tax withholding?
Everyone who earns income in the US—regardless of how it is earned—is subject to tax withholding. However, the process looks different for some people depending on their particular job or business status (more on this later).
Is there a difference between withholding tax and income tax?
While withholding tax is tax paid on income, it is not exactly income tax. Confusing, eh? With income tax, the taxpayer (the employee, in this particular case) calculates the tax amount, files an income tax return, and makes the tax payment themselves. In the case of withholding tax, the employer withholds the amount from the employee’s paycheck and is responsible for sending it to the government.
Withholding tax may be viewed as an advance the government is getting on the taxpayer’s income tax.
How does withholding tax work?
Employers withhold a set amount of federal income tax from each employee’s paycheck and send it to the IRS in their name. The amount deducted then shows up on the employee’s pay stub. How much employers withhold depends on a few factors, including:
- How much an employee earns
- Their filing status (single or married)
- The withholding allowances they claim
When the employee fills out a W4 tax form, the factors listed in the bullets above are detailed in the form, and based on this, federal withholding tax is calculated. If too little withholding tax is deducted throughout the year (because the W4 form was filled out incorrectly, or for another reason) the employee may owe taxes to the IRS when filing their tax return or they may receive a penalty for underpaying. On the other hand, if employee has paid too much in withholding taxes throughout the year, they’re eligible for a tax refund from the IRS.
In addition to federal withholding tax, there are also state withholding requirements to consider. Most states also have their own withholding programs for state income taxes. Only nine states are outliers: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming don’t impose state income taxes, and New Hampshire doesn’t tax earned wages. Check out your state’s tax rules using the IRS’ list of state government websites.
Do independent contractors have to pay withholding tax?
Because they work for themselves, independent contractors technically don’t have to pay withholding taxes, but they do have to pay federal income tax in the form of estimated quarterly taxes. Individuals like sole proprietors, partners, and S corporation shareholders generally have to pay estimated taxes if they think they’ll owe at least $1,000 when they file their taxes.
If you’re an independent contractor, you pay estimated taxes four times a year: January, April, June, and September. If you don’t pay estimated quarterly taxes throughout the year or if you underpay, you could receive a penalty.
What is nonresident withholding tax?
Nonresident aliens—people who were born outside the US and don’t have citizenship or a green card—have to pay withholding taxes on income that comes from the US. Nonresident aliens who are engaged in a trade or business in the US during the year have to file Form 1042. Their income will likely be taxed at a rate of 30 percent, unless there’s a special tax treaty between their country of origin and the US.
If you’re a nonresident alien doing business in the US, check out these IRS rules to learn more.
Who is exempt from tax withholding?
In order for a taxpayer to be exempt from tax withholding, they must meet two IRS criteria:
1) They must have had no tax liability for the previous year (meaning: nothing was owed), and 2) also the taxpayer does not expect any tax liability for the current year.
If you think you might be exempt, you have to update Form W-4 to indicate that your employer shouldn’t deduct any withholding tax. Your exempt status will only be valid for the tax year in which the form was submit to the employer. If you want your exemption to last another tax year, you need to submit a new W-4 form by February 15 of the tax year in which you are claiming exempt status.
How to calculate your withholding tax as an employee
If you’re an employee, it’s a good idea to calculate your tax withholding yourself, so you don’t overpay or underpay in taxes. The IRS recommends that you check your withholding tax early in the calendar year, any time tax law changes, and whenever you have a significant life change, like an adjustment to your income or home purchase.
Before you calculate your withholding tax, make sure you have the following information on hand:
- Your filing status
- Your primary income source
- Any additional income sources
- The end date of your most recent pay period
- Your wages per period and the year-to-date (YTD) totals
- The amount of federal income tax per pay period and the total paid year-to-date
- Whether you claim standardized or itemized deductions
- The amount of tax credits you take
From there, you can use the IRS Tax Withholding Estimator to calculate your withholding taxes. If you need to reference the 2022 marginal tax rates—which have been adjusted for inflation—this withholding table shows a breakdown:
|Tax Rate||Single||Married Filing Jointly|
|10%||$10,275 and under||$20,550 and under|
|12%||Over $10,275||Over $20,550|
|22%||Over $41,775||Over $83,550|
|24%||Over $89,075||Over $178,150|
|32%||Over $170,050||Over $340,100|
|35%||Over $215,950||Over $431,900|
|37%||Over $539,900||Over $647,850|
Where can an employee see the amount that has been withheld?
The employee (the taxpayer, in this case) can see the withholding tax amount on their paystub and also the annual amount that has been withheld can be viewed on Form W2.
Employers are responsible for preparing, filling out, and filing Form W2 for each employee. We’ve got detailed instructions on how to fill out and file form W2 here.
How to change your withholding tax amount as an employee
Only the employee can change the tax amount withheld from their paycheck. This may happen due to lifestyle changes, like getting married or adopting a child, and income changes, like getting a promotion or student loan interest deduction—all these may affect how much an employee pays withholding taxes.
If you are an employee and you need to change your withholding tax amount, here are the steps to take:
- Calculate your tax withholding using the IRS Tax Withholding Estimator.
- Complete a new Form W-4 and submit it to your employer.
- If you receive a pension, annuity, or other deferred income, complete a new Form W–4P and submit it to your payer.
How to change your estimated taxes as an independent contractor
If you’re an independent contractor and want to change how much you pay in estimated taxes, you can either pay less than the suggested amount on an estimated payment, or submit an additional payment before the end of the year.
How employers and business owners can calculate withholding tax
As an employer, you’re responsible for paying withholding tax on your employees’ wages, as well as Social Security and Medicare taxes. If it’s your first time calculating withholding tax for your small business, follow the below steps to ensure your payroll is accurate:
- Review your employees’ W-4 forms: You need to know their filing status, how many dependents they claim, additional income information, and any additional amounts that your employees request to be withheld.
- Review payroll information: You need to know your business’s payroll schedule and the gross pay amount for the pay period in question.
- Use the IRS worksheets and tables to calculate withholding tax: Check out the IRS’ Publication 15-T: Federal Income Tax Withholding Methods and follow the instructions to calculate your employees’ withholding tax amounts. If you have an automated payroll system, you can use Worksheet 1A and the Percentage Method tables to calculate federal income tax withholding. If, however, you compute payroll manually, you can use the Wage Bracket Method tables to determine federal income tax withholding.
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