Whether you’re an employee or an employer, it’s important to understand the concept of withholding tax. It’s a key part of running payroll and ensures the government receives the tax it’s owed on time from every paycheck. This guide covers 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 for each employee depends on certain factors, including:
How much an employee earns
Their filing status (single or married)
Their number of dependents and tax credits
Whether an employee chooses additional withholding, such as for multiple jobs or a working spouse
When the employee fills out a W-4 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 W-4 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 an 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, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming don’t impose state income taxes. 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 earned 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:
They must have had no income tax liability for the previous year (meaning: nothing was owed), and
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 submitted 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, whenever tax law changes or when you have a significant life change, such as 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 2026 marginal tax rates (adjusted for inflation), this withholding table shows a breakdown:
Tax Rate | Single | Married Filing Jointly |
10% | $12,400 and under | $24,800 and under |
12% | Over $12,400 | Over $24,800 |
22% | Over $50,400 | Over $100,800 |
24% | Over $105,700 | Over $211,400 |
32% | Over $201,775 | Over $403,550 |
35% | Over $256,225 | Over $512,450 |
37% | Over $640,600 | Over $768,700 |
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 pay stub, and also the annual amount that has been withheld can be viewed on Form W-2.
Employers are responsible for preparing, filling out, and filing Form W-2 for each employee. Just follow these detailed instructions for how to fill out and file Form W-2.
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 of which may affect how much an employee pays in 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 tax 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 steps below 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. However, if you compute payroll manually, you can use the Wage Bracket Method tables to determine federal income tax withholding.
If you need help calculating your employees’ withholding taxes, turn to Gusto. Our payroll software is designed for small businesses. Whether you’re setting up payroll for the first time or looking to improve your processes, we’ll help you run payroll, file payroll taxes, and stay compliant. Learn more about what we offer, or create an account today.
Frequently Asked Questions
What’s the difference between withholding tax and estimated tax?
If you’re an employer, you’re taking withholding tax from your employees’ paychecks. If you’re self-employed as an independent contractor, freelancer, or a business owner who doesn’t receive a salary because you’re not classified as an employee (such as a sole proprietor, partner, or S corporation shareholder), then you’re paying estimated taxes.
Another difference is that the withholding tax is automatically withheld from every paycheck, and the regular amount of tax that’s taken is based on how an employee fills out their W-4 form. Estimated taxes, on the other hand, are paid quarterly to the IRS. They can vary, according to your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year.
You can figure out your amount of estimated taxes with Form 1040-ES. They can also be set up as recurring payments, scheduled as future payments, or even set up to be paid weekly, biweekly, or monthly. The frequency doesn’t matter as long as enough taxes are paid quarterly.
Can withholding tax be adjusted or changed on my paycheck?
Employees can change how much is withheld from their paychecks as much as they want. Each change, though, requires a new W-4 form to be submitted. They also can’t expect the new withholding to be automatically reflected in the next paycheck. It might take a couple of payroll periods before the change is reflected in your take-home pay.
What penalties apply to employers for failing to withhold or remit taxes properly?
Employers are required to deposit employment taxes fully on a timely basis (monthly or semi-weekly schedule), according to IRS remit requirements, or they’ll be fined and charged interest. This is how the IRS states it calculates penalties:
Number of days your deposit is late | Amount of the penalty |
1 to 5 calendar days | 2% of your unpaid deposit |
6 to 15 calendar days | 5% of your unpaid deposit |
More than 15 calendar days | 10% of the unpaid deposit |
More than 10 calendar days after the date of your first notice or letter (for example, CP220 Notice), or the day you get a notice or letter for immediate payment (for example, CP504J Notice). | 15% of your unpaid deposit |
Are bonuses and supplemental wages taxed at a different withholding rate?
A common misconception is that bonuses are taxed more than wages. While they’re typically withheld at a different rate, they’re actually taxed at the same rate as your income tax when you file your tax returns.
Bonuses are one type of supplemental wage. Here are some others:
Commissions
Overtime pay
Severance pay
Back pay or retroactive pay
Accrued leave payouts
Awards and prizes
Stock options
Tips
The tax on these supplemental wages can be withheld at a flat 22% rate. If the supplemental wages exceed $1 million in a calendar year, then that flat rate for withholding increases to 37%.
Employers can choose that flat percentage method under certain circumstances, issuing separate payments from typical paychecks. Or they may choose an aggregate method to calculate the withholding. With the latter option, employers issue the supplemental payment with the regular paycheck, and the withholding rate is based on that combined income.
How does withholding tax apply to remote employees working in a different state?
The state where the work is performed typically collects the withholding taxes, but certain states might have a “convenience of the employer” (COE) rule in place. That means the employer’s home state collects the taxes, unless the employment requires you to work from another state.
For example, if an employee chooses to work remotely but it’s not necessary, then this rule applies, and the state where the employer is based collects the taxes. Some of these states with a convenience rule apply it in a limited way while others implement it in a broader or stricter fashion.
The states with the COE in place are:
Alabama
Connecticut (only for nonresident employees who live in states that also have a convenience of the employer rule)
Delaware
New Jersey (only for nonresident employees who live in states that also have a convenience of the employer rule)
New York
Nebraska (exempt from it if physically working in the state seven days or less)
Oregon (only for nonresidents in managerial roles)
Pennsylvania (applies to hybrid nonresident employees, unless the company requires that the work be performed where the employee resides, or the nonresident employee lives in a state with a reciprocal agreement, including Indiana, Maryland, New Jersey, Ohio, Virginia, and West Virginia)
To avoid double taxation, states may also have a reciprocity agreement in place so taxes are only paid to one state. Or in order to reduce your tax bill for the state where you live, they may offer resident state tax credits for the amount you paid to the state where you worked.
Can employees request additional voluntary withholding beyond the calculated amount?
Yes, line 4(c) in the W-4 form is an optional field, but employees can put an extra withholding amount there. There are also lines on state forms to do the same. A dual-income household or earning additional income from a second job or non-wage earnings (e.g., investments) are some of the instances when someone might want to request an additional amount to withhold.
How do tax law changes impact withholding amounts during the year?
Changing payroll formulas, tax deductions, and tax credits affect how much is withheld and how much is in take-home pay. At the beginning of the year, employees should check what annual changes the IRS is implementing to see how it impacts their withholdings and how their taxable income is calculated. This way, they can update their withholdings, if needed, with a new W-4 form to ensure they won’t owe money to the IRS when it’s time to file their tax returns.
