What is Tax Withholding? All Your Questions Answered by Napkin Finance

Tax Withholding

To Have and Withhold

Tax withholding is money your employer takes out of your paycheck each pay period. Your employer then sends that money to the federal and state governments to pay your income taxes on your behalf.

How determined

When you start a new job, your employer gives you a W-4 tax form to fill out. You use this to report your name, address, and Social Security number, plus three important pieces of information:

  • Your tax filing status (whether you file as single, married filing jointly, etc.)
  • Your withholding allowances (whether you claim any dependents on your taxes)
  • Whether you want additional money withheld from each paycheck

Your employer then uses this information to calculate how much of each paycheck to withhold for taxes.

Why important

The IRS wants you to pay taxes as you make money, not all at once at the end of the year. Tax withholding makes this process easier by making employers do the legwork of paying your taxes for you as you go.

Once the year is over, you file your taxes and settle up with the IRS. If you paid too much through withholding, you’ll get a refund. If you paid too little, you’ll need to send the government a check for the balance. (And if you paid far too little, you’ll need to pay the balance plus a penalty for underpaying.)

“Make sure you pay your taxes; otherwise you can get in a lot of trouble.“

—President Richard Nixon

What applies to

Most money you earn at your job will be subject to withholding, including:

  • Your salary (or hourly pay)
  • Bonuses
  • Commissions

And employers aren’t the only ones who have to jump through the hoops of withholding—gambling winnings typically have taxes withheld too. If you hit it big in Vegas, don’t expect to go home with the full pot. The casino will keep a portion of your winnings to send to the IRS for taxes, and send you a tax form in the mail to file with your annual return.

When to change

After you file your initial W-4, it’s good practice to check in on it:

  • Each year
  • Anytime you have a big life change (like getting married or having a kid)
  • If Congress makes major tax law changes

You can fill out a new W-4 anytime you need to. It’s important to make sure the right amount is being withheld.

Estimated tax payments

You need to pay your taxes as you earn income during the year. However, not everyone has an employer who withholds taxes (we see you, freelancers). Contractors and other 1099 workers instead make estimated tax payments to the IRS four times a year (once per quarter) based on what they expect to earn during the year.

Even if your employer does withhold taxes, it’s possible you could need to make estimated tax payments to make sure you’re paying enough during the year. You might do this if you realize that you messed up your W-4 and didn’t have enough withheld, or if you have substantial income from other sources (like investments).

Estimated payments can be a good way to avoid a penalty when you file your taxes.

Conclusion

Tax withholding is when your employer takes money out of your paycheck to pay taxes throughout the year on your behalf. How much money your employer withholds depends on the information you’ve included in your Form W-4. It’s important to fill out your W-4 carefully because the IRS may charge you a penalty if you don’t have enough money withheld.

Fun facts
  • The vast majority of the federal government’s money comes from taxes. Most of that is from voluntary payments, but the IRS collects nearly $60 billion each year via enforcement activity.
  • The average individual tax refund is more than $2,500, and while getting that money is fun, all it really means is that the government got interest-free loans for the year from tens of millions of Americans.
Key takeaways
  • Employers typically withhold taxes from every paycheck you earn and send this money to the government on your behalf.
  • Tax withholding helps make sure that people pay taxes as they go.
  • When you get a new job, you’ll fill in Form W-4. The information you put on the form tells your employer how much to withhold from each of your paychecks.
  • It’s important to have the right amount of money withheld to avoid owing a penalty when you file your taxes.
  • You can update your W-4 anytime you need to adjust your withholdings.
It’s called gross income because it’s gross how much gets withheld for taxes. — Napkin Finance

References

https://www.irs.gov/individuals/employees/tax-withholding
https://www.irs.gov/pub/irs-pdf/fw4.pdf
https://www.irs.gov/payments/pay-as-you-go-so-you-wont-owe-a-guide-to-withholding-estimated-taxes-and-ways-to-avoid-the-estimated-tax-penalty
https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes
https://www.irs.gov/newsroom/tax-withholding-how-to-get-it-right
https://www.irs.gov/taxtopics/tc306
https://www.investopedia.com/terms/w/withholdingtax.asp
https://wallethub.com/blog/tax-day-facts/11835/
By signing up, I agree to Napkin Finance’s Terms of Service and Privacy Policy.

The simple information you need
to clean up your not-so-simple finances.