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Withholding tax may sound like a new concept, but there’s a good chance you’ve already dealt with it: As the name implies, it's a sum of money withheld from most employees’ paychecks. The important thing is to make sure you’re having the right amount taken out.
What is withholding tax?
Withholding tax is tax your employer withholds from your paycheck and sends to the IRS on your behalf. If too much money is withheld throughout the year, you’ll receive a tax refund. If too little is withheld, you’ll probably owe money to the IRS when you file your tax return.
Withholding tax is typically made up of federal, state, local and FICA taxes. FICA taxes include a 6.2% Social Security tax and a 1.45% Medicare tax.
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Who pays withholding tax?
Most employees are subject to withholding tax. Your employer is the one responsible for sending it to the IRS. In order to be exempt from tax withholding, you must have owed no federal income tax in the prior tax year and you must not expect to owe any federal income tax this tax year.
» More: How much do you have to make to file taxes?
How withholding taxes are calculated
The amount of federal and state tax your employer withholds from your check largely depends on what you put on your Form W-4, which you probably filled out when you started your job. Here are some things to know:
Form W-4 asks about your marital status, dependents and other factors to help you calculate how much to withhold. The less you withhold, the less tax comes out of your paycheck.
What you put on your W-4 then gets funneled through something called withholding tables, which your employer's payroll department uses to calculate exactly how much federal and state income tax to withhold.
You can change your W-4 at any time. Just download a blank one from the IRS website, fill it out and give it to your human resources or payroll team.
» More: State taxes can vary based on where you live. How state income tax rates work.
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Types of withholding and payroll tax
Here's a breakdown of the taxes that might come out of your paycheck. Some taxes, like your federal, state, local and FICA taxes, will be withheld from your paycheck by your employer. A few others, like FUTA and SUTA, are your employer's responsibility and not withheld.
Federal income tax. This is income tax your employer withholds from your pay and sends to the IRS on your behalf. The amount largely depends on what you put on your W-4.
State tax: This is state income tax withheld from your pay and sent to the state by your employer on your behalf. The amount depends on where you work, where you live and other factors, such as your W-4 (and some states don’t have an income tax).
Local income or wage tax: Your city or county may also have an income tax. This money might go toward such expenses as the bus system or emergency services.
Social Security tax: Frequently labeled as OASDI (it stands for old-age, survivors and disability insurance), this tax typically is withheld on the first $160,200 in 2023 at a rate of 6.2%. For 2024, the tax will be withheld on the first $168,600. Paying this tax is how you earn credits for Social Security benefits later.
Medicare tax: Sometimes referred to as the “hospital insurance tax,” this pays for health insurance for people who are 65 or older, younger people with disabilities and people with certain conditions. It is a tax of 1.45% on your earnings, and employers typically have to withhold an extra 0.9% on money you earn over $200,000.
FUTA tax: This stands for Federal Unemployment Tax Act. The tax funds a federal program that provides unemployment benefits to people who lose their jobs. Employees do not pay this tax or have it withheld from their pay. Employers pay it.
SUTA tax: The same general idea as FUTA, but the money funds a state program. Employers pay the tax.
Tax | Employee pays | Employer pays |
|---|---|---|
Federal income tax | Employee pays. | |
State tax, local income or wage tax | Depends on location. | Depends on location. |
Social Security tax (aka OASDI) | 6.2% (only the first $147,000 of earnings in 2022; $160,200 in 2023). | 6.2% (only the first $160,200 of earnings in 2023;$168,600 in 2024). |
Medicare tax | 1.45%. | 1.45%. |
Additional Medicare tax | 0.9% (on earnings over $200,000 for single filers; $250,000 for joint filers). | |
Federal unemployment tax (FUTA) | Employer pays. | |
State unemployment tax (SUTA) | Employer pays. |
Did you know...
The Social Security tax and Medicare tax above are collectively referred to as “FICA taxes.” You and your employer split the burden of paying them.
» MORE: See what the maximum monthly Social Security benefit is this year
How to check your tax withholding
The IRS recommends checking your withholding for lots of reasons, including if you work a seasonal job, claim the child tax credit or had a large refund or tax bill last year.
To see whether you may need to change your withholding, you can use the IRS’ Tax Withholding Estimator. Before you get started, have the following information ready for yourself (and your spouse, if you’re married): your most recent pay stubs, information about other sources of income and your most recent income tax returns. You can also use our W-4 calculator to get a general sense of whether you're on track with your tax withholding.
If you need to change your withholdings, the process is fairly straightforward: Just fill out a new W-4 and submit it to your employer. Withholding tax comes out of your paycheck throughout the year, so it’s better to make changes to your withholding sooner rather than later.
» Bonuses can impact your tax bill. More on the bonus tax rate and how bonus taxes are withheld.
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Withholding tax vs. estimated tax
Unlike withholding tax, estimated taxes are not paid by an employer. Estimated taxes payments are made by people who earn income that is not subject to withholding. For example, someone who is self-employed may need to estimate their tax liability and make payments quarterly.
» Are you your own boss? Learn more about estimated tax payments.
The importance of tax withholding
Remember, one of the big reasons you file a tax return is to calculate the income tax on all of your taxable income for the year and see how much of that tax you’ve already paid via withholding tax. If it turns out you’ve overpaid, you’ll probably get a tax refund. If it turns out you’ve underpaid, you’ll have a tax bill to pay.
If you ended up with a huge tax bill this year and don’t want another, you can use Form W-4 to increase your tax withholding. That’ll help you owe less (or nothing) next year.
If you got a huge tax refund, consider using Form W-4 to reduce your tax withholding. You’re giving the government a free loan and — even worse — you might be needlessly living on less of your paycheck all year. It may feel great to get a tax refund from the IRS, but think of how life might’ve been last year if you’d had that extra money when you needed it for groceries, overdue bills, getting the car fixed, paying off a credit card or investing.
I've been trained on a vast corpus of information that includes financial topics like taxes, payroll, and the intricacies of the U.S. tax system. My training data encompasses a wide range of articles, books, and resources that enable me to understand and provide insights on topics like withholding tax.
Withholding Tax: A Comprehensive Overview
1. Introduction to Withholding Tax:
- Withholding tax is essentially a prepayment of income tax that is withheld from an individual's wages or salary by their employer.
- This system ensures that taxpayers meet their tax obligations throughout the year rather than in one lump sum.
2. Components of Withholding Tax:
- Federal Tax: Based on the individual's income and tax brackets as defined by the federal government.
- State Tax: Varies depending on the state of residence and its specific tax rates.
- Local Tax: Applicable in some areas and typically funds local services like public transportation or emergency services.
- FICA Taxes: Includes Social Security (6.2% up to a certain limit) and Medicare (1.45% on all earnings).
3. Determining the Amount of Withholding:
- Determined primarily by the details provided on the Form W-4. This form considers factors such as marital status, dependents, and other income.
- Employers use withholding tables, provided by the IRS, to determine the exact amount of federal and state income tax to withhold.
4. Adjusting Withholding:
- Taxpayers can adjust their withholding amounts by updating their Form W-4 with their employer.
- Reasons for adjusting might include changes in marital status, having a child, or experiencing significant changes in income.
5. Additional Tax Components:
- Social Security Tax (FICA): Funds the Social Security program, providing benefits for retirees, the disabled, and survivors.
- Medicare Tax: Supports health insurance for specific groups, including the elderly and those with disabilities.
- FUTA and SUTA Taxes: Support unemployment programs at the federal and state levels, respectively.
6. Checking and Adjusting Withholding:
- The IRS recommends periodic reviews of withholding, especially after significant life events or changes in income.
- Tools like the IRS’ Tax Withholding Estimator can help individuals determine if their current withholding is appropriate.
7. Distinction Between Withholding Tax and Estimated Tax:
- While withholding tax is facilitated by employers, estimated taxes are for those with income not subject to regular withholding, such as self-employment income.
8. Importance of Proper Withholding:
- Accurate withholding ensures that taxpayers neither owe a significant amount nor receive excessive refunds.
- Adjusting withholding can help optimize cash flow, ensuring taxpayers have adequate funds throughout the year.
In conclusion, understanding withholding tax is crucial for employees to ensure compliance with tax obligations and optimize their financial planning. Properly managing withholding can lead to a smoother tax filing process and better financial outcomes.
