Key Takeaways
- Tax withholding is the amount that gets held back from a paycheck or other type of payment for tax purposes.
- The amount of tax withheld doesn’t always line up exactly with the amount of tax owed, but it often generally covers the approximate tax liability.
- When filing taxes, if it turns out too much money was withheld, you would receive a tax refund; if too little was withheld, you would owe taxes and potentially need to pay a penalty as well.
How Tax Withholding Works
A tax withholding is money set aside from wages to cover the taxes you owe on those wages. In many cases, your paycheck will be less than your full wages because your employer has withheld some money to cover your tax liability. Your employer then sends that money to relevant tax authorities, including the IRS.
Note
Employees in many states have withholdings that cover their federal and state taxes.
The exact amount withheld from your pay depends on several factors, such as income, deductions, and relevant tax rates. While tax withholdings are intended to match how much you'll owe when you file your taxes, the amounts may not always align perfectly.
With a paycheck, for example, your employer typically asks you to complete a W-4, which is a form that calculates what your withholding will be. This form will let you specify things like your number of dependents, which helps determine how much your employer should withhold.
For example, if you have children you claim as dependents, you could add that information to your W-4 to reduce your tax withholding. However, if you don’t claim any dependents, you could be eligible for a tax refund because your withholdings were more than what you owed.
On the flip side, if you claim more deductions on a W-4 than you’re entitled to, you might receive a higher paycheck, but could end up owing taxes and/or have to pay penalties.
If you're a freelancer who isn't an employee, you generally won't have paycheck withholdings. You'll need to set aside money on your own through estimated tax payments. That way, you can meet your tax liability throughout the year, rather than owe penalties and be hit with unexpected bills during tax-filing season.
Note
The IRS provides a withholding calculator that can help you decide how much you should withhold from each paycheck based on how you answer the calculator's questions.
Example of a Tax Withholding
Suppose you earn $2,000 per pay period. Instead of receiving $2,000, you receive a paycheck for $1,600, because your employer has set aside $400 as a tax withholding. For the year, you pay $10,400 in withheld taxes. When you file your taxes, you find out you only owe $6,000, so you get a $4,400 refund.
The following year, you reduce your tax withholding so that you get a bigger paycheck while setting aside just enough money to cover your taxes instead of overpaying like you did the year before.
What a Tax Withholding Means for Individuals
Understanding tax withholding is important when it comes to your tax management and budgeting. If you don’t fill out your W-4 form accurately, for example, you might receive a higher paycheck and spend more money, only to have a big tax bill later on that you can't afford.
Or, you might consider intentionally having more withheld from their paycheck so they end up with a tax refund after they file. However, you may want to consider other saving strategies, such as depositing a small amount from each paycheck into an interest-bearing bank account.
Frequently Asked Questions (FAQs)
Is it better to claim 1 or 0 on your taxes?
It depends. If you claim zero dependents on your W-4, your employer will withhold a bigger chunk of your paycheck. This means that you'll get less money every paycheck, but you're likely to have your tax bill covered, and then some. Claiming one dependent will reduce your withholding and may cause you to owe taxes when you file the following year, depending on your tax situation.
What does withholding tax do to your paycheck?
Withholding taxes from your paycheck decreases the amount of your take-home pay. The bigger your withholding, the smaller the check. You can change your withholding on IRS Form W-4. The more dependents you claim, the smaller your withholding will be.
