What is tax withholding?

Anyone who’s ever paid attention to their pay stubs will know that take-home pay is always a little less than total earnings for a pay period. That difference is because of things like deductions and tax withholdings.

How money is withheld, and how much, depends on a lot of factors. This guide will tell you more about where the money goes and how it might affect your paycheck.

Key takeaways

  • Withholding refers to the money an employer holds back from a taxpayer’s earnings.
  • Employers pay tax withholdings to the federal and sometimes state government on their employees’ behalf.
  • Examples of employment taxes that are withheld include federal income taxes, Social Security taxes and Medicare taxes. 
  • The amount withheld depends on an employee’s individual circumstances.

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What does tax withholding mean?

Tax withholding refers to the money an employer withholds from each employee’s paycheck. Both federal and state taxes are collected on a pay-as-you-go basis. The employer pays this tax directly to the government on the employee’s behalf. Because taxes are paid throughout the year, withholding can give taxpayers a better idea of what to expect at tax time and help them avoid penalties.

At year-end, employers file a Form W-2 for each employee, which shows the total wages paid and federal, state and local income taxes withheld over the past year. According to the IRS, the amount withheld for federal taxes is dependent on:

  • The amount of money an employee earns
  • How the employee fills out Form W-4

Understanding Form W-4

Form W-4 is an IRS document that an employee fills out when starting a new job. In most cases, the employer provides this form. Employees may be required to complete two Form W-4s if they are subject to both federal- and state-level tax withholdings. The information collected from Form W-4 tells the employer how much to withhold from an employee’s paycheck. This information may include:

  • Filing status: The employee indicates whether they are single, married and filing jointly, the head of a household, married and filing separately, or a qualifying widow(er).
  • Number of jobs held and spouse’s employment status: An employee who holds more than one job or whose spouse holds a job and files jointly can also indicate this on Form W-4 to get the right withholding amount. 
  • Number of dependents: An employee can claim dependents, including qualifying children, if they earn less than $200,000 per year (or less than $400,000 if married and filing jointly).
  • Other adjustments: This optional step allows employees to account for other factors that reflect their situation and might make withholdings more accurate. For example, you can note other income—from interest, dividends or retirement plans—and claim other deductions like the child tax credit.

Employees can fill out a new form anytime they have a personal or financial life change, like adding a dependent or starting another job. 

Federal tax withholding vs. state tax withholding

Federal tax withholding and state tax withholding are similar in nature. But federal withholding rules are universal across the U.S., while state withholding rules can vary. 

For example, there are some states with no income tax where taxpayers may only be subject to federal tax withholding.

Depending on where you live and work, you may be subject to both federal and state withholding on your income. You can refer to your state’s government website for more information.

How to calculate tax withholding

The IRS has a tool that might help you estimate your tax withholdings. You can also use it to see how your refund, take-home pay or tax burden may change if you adjust withholdings. 

When using the tool, having pay stubs and old tax returns handy might help you get the most accurate estimate. 

Tax withholding FAQs

How much should I withhold for taxes?

Your employer typically withholds federal income taxes from your paycheck using information from your W-4. But you can adjust withholdings if you want more or less taken out at tax time by submitting a new W-4. The right amount of tax withholding varies depending on your personal situation. If you’re unsure, try using the tax withholding estimator tool. 

Is it better to claim 1 or 0 allowances on a W-4?

Allowances is a portion of the W-4 individuals must fill out to determine how much tax will be withheld from their pay. In the past, individuals were given the option to claim a 0 or a 1 on their taxes—the more allowances you claimed, the less income tax your employer withheld. As of 2021, Form W-4 uses a different formula. If you’re prompted to select 1 or 0, this is an outdated version of the form. 

Should taxes be withheld from unemployment payments?

Unemployment payments are considered taxable income and must be reported on your tax return. If you receive unemployment benefits, you may be able to use Form W-4V to voluntarily ask that federal income taxes be withheld.

Those who choose not to withhold taxes from their unemployment benefits instead might make quarterly estimated tax payments by using Form 1040-ES.

Tax withholding in a nutshell

Withholding taxes from your earnings could help you avoid a large tax bill at the end of the year. Understanding the amount that’s being withheld from your wages can help you prepare for tax time. For more information, you can use this guide to learn how to file taxes.

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