Everything You Need to Know About Tax Withholding

Tax withholding refers to the percentage of your income that your employer takes out from your paychecks for federal and state taxes. Since the U.S. has a pay-as-you-go tax system, you’ll gradually pay your tax bill throughout the year instead of making one lump sum payment when you file taxes.   

When you choose to have taxes withheld from your paycheck, it can greatly reduce the amount you owe come tax time. Knowing the ins and outs of withholding is important because the amount withheld directly relates to your refund. 

How does tax withholding work? 

You’ll have the opportunity to withhold income when starting a new job. Your employer will have you complete Form W-4, which tells them how much money to reserve from your paycheck for taxes. When tax season comes around, whatever your employer withheld counts toward your tax bill. 

When you submit a W-4 to your employer, they will use the information to withhold the correct percentage of federal and state income from your paycheck. Withholding differs from person to person, depending on the following criteria:  

  • Filing status 
  • Job status – the number, type of jobs, and the income from those jobs 
  • If your (or your spouse’s) wages from a second job are $1,500 or less 
  • Dependents and their care expenses 

Learn how to complete Form W-4 here.   

Who must withhold a portion of their income for taxes? 

If you live in Alaska, Florida, Nevada, South Dakota, Tennessee, Washington, Texas, or Wyoming, you won’t have to complete a state W-4, since these states do not collect income taxes. But, if you meet the federal requirements to file taxes, you must set up federal withholding with your employer. 

Am I withholding enough money for taxes?  

Finding the sweet spot is important when setting your tax withholding percentage and filing your tax return. Ideally, you should aim to withhold just enough to cover your tax liability, avoiding any unpleasant surprises during tax season.   

While receiving a tax refund may seem like a windfall, it’s essentially an interest-free loan to the government. Striking the right balance between how much money you reserve for taxes and the amount you actually end up owing ensures you keep more of your hard-earned money throughout the year while still meeting your tax obligations.  

Suppose you have a tax bill at the end of the year or receive an excessive refund each year. In that case, you may consider updating your W-4 so that your withholding percentage matches your tax liability.  

How can I estimate my tax liability?  

Your tax liability is essentially the tax bill you owe to a federal, state, or local authority. The money reserved by way of tax withholding counts as payments made in anticipation of your estimated tax liability. Knowing your estimated tax liability is helpful information when completing your W-4 and setting the amount you will have withheld throughout the year.   

One of the best ways to estimate your tax liability is to refer to the prior year. If your financial situation hasn’t changed significantly, your previous year’s tax return can give you a baseline estimate for the current year. Your total tax liability can be found on line 24 of Form 1040. If you filed with TaxSlayer last year, reviewing your prior year’s return is as easy as logging into your account.  

Calculating your federal withholding percentage offers another method for determining your tax liability and, ultimately, how much will be withheld from your paycheck. Continue reading to learn more about calculating your federal withholding percentage.  

How can I calculate my federal withholding percentage? 

Your tax rate depends on the information entered on your W-4. You can estimate how much money will be withheld from your income using the IRS Withholding Calculator

Changing your withholding percentage 

You can change your tax withholding percentage any time by contacting your employer. But the IRS recommends adjusting your W-4 anytime your personal or financial situation changes. Below, you’ll find a few common reasons to modify your W-4: 

  • You’ve had a change in income 
  • You’ve recently expanded your family (marriage, birth of a child, adoption, etc.) 
  • You’ve recently started a small business 
  • You bought a new home 
  • You’re retiring 
  • You have increased itemized deductions, interest, dividends, or self-employed income 

For more information, read Tax Filing Tips: When to Check Your Withholdings. 

Can I be exempt from tax withholding? 

Some special circumstances may exempt you from federal withholding. If you didn’t owe federal taxes last year and expect to owe nothing this year, you might be eligible for an exemption. To learn more, read Am I Exempt from Federal Withholding? 

Tax Withholding for Retirement Income 

Once you retire, you will still generate income through pensions, government benefits, or IRA withdrawals. You must withhold some of this federal income using the following forms. 

Form W-4P (h3) 

You’ll complete Form W-4P if you receive pension, IRA, or annuity payments. If you forget to fill out this form, taxes from pensions will be withheld based on a single filing status with no adjustments.  

Form W-4V (h3) 

You will get Form W-4V if you receive unemployment compensation, Social Security benefits, or other types of payment from the government.  

Tax Withholding FAQs 

What is the purpose of withholding income for taxes? 

Withholding serves as a financial cushion for you come tax time. Setting aside money throughout the year greatly reduces your tax bill when it’s time to file taxes. 

How many allowances should I claim? 

The IRS removed allowances in 2020 with the redesign of the W-4. The new W-4 follows a five-step process to calculate your expected tax liability.

Do I need to withhold income if I only worked for a portion of the year? 

Yes, but you wouldn’t use the standard withholding method since you’d reserve too much of your income for taxes. For more information, read Part-Year Tax Withholding for Temporary Employees. 

I completed my W-4. What do I do next? 

Once you give your employer your W-4, you can hang tight for the next few months. When tax season starts, your employer will give you a W-2, which lists your earnings for the tax period. You then would use your Form W-2 to file your taxes.  

TaxSlayer makes filing your tax return fast and easy. Start now and get your maximum refund guaranteed! 

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