How much tax should I have withheld?

Elizabeth Rosen
by Elizabeth Rosen, Contributor

Withholding tax (also known as “payroll withholding”) is essentially income tax that is withheld from your wages and sent directly to the IRS by your employer. The employer then sends the withheld amount to the appropriate taxing authority. Federal and state governments use the revenues to fund programs such as Social Security, Medicare, unemployment compensation and worker’s compensation.

Withholding tax is almost like a credit against the income taxes that you owe for the year. By subtracting this amount from each of your paychecks, the IRS is basically withholding your anticipated tax payment as you earn it ― this system is sometimes called “pay-as-you-earn” taxation. There are two main IRS tax forms that are used to report and manage withholding tax.

W-2 Tax Form

Part of the “W series” of tax forms, IRS Form W-2 is a six-part federal Wage and Tax Statement. The W-2 IRS tax forms are used by employers annually to convey wage and tax information to their employees. The W-2 form is used to report how much an employee earned during the tax year, as well as the taxes withheld for federal and state tax purposes. Tax Form W-2 is also used to report the Federal Insurance Contributions Act (FICA) tax, which goes to pay for programs that cater to retirees and the disabled. The FICA tax has two components ― the Social Security portion and the Medicare portion ― which are separately reported on Tax Form W-2.

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W-4 Tax Form

Also part of the “W series” of tax forms, the IRS Tax Form W-4 is used by employers to withhold the proper amount of federal income tax from their employee’s paychecks. If you are an employee, you will be required to fill out a W-4 tax form when you begin a new job. The IRS usually recommends for taxpayers to submit a new (revised) W-4 form every year. You should also file a new W-4 form any time your personal/financial situation changes, or if you simply want to adjust your withholding allowances. Once you fill out Tax Form W-4 and give it to your employer, they will complete their appropriate sections of the form and carry out the process from there.

The W-4 form allows you to manage the amount of taxes that are withheld from your paycheck — and based on the taxes that you owe, this also influences the size of your tax refund. In general, the more money that is withheld from your wages throughout the year, the larger your tax refund can be (because you’ve essentially overpaid the IRS). While getting a tax refund can feel great, remember that it’s only the money you earned during the year being returned to you.

Managing Your Withholding Tax

Withholding tax is withheld from your wages by your employer. This means that each time you start a new job, your employer will give you a W-4 Tax Form to complete that determines the amount of Federal income tax that is withheld from each paycheck.

While many people prefer to have too much tax taken out so they can look forward to a tax refund in the spring, overpaying your taxes means you are allowing the IRS to hold onto your money for no reason — it’s basically giving an interest-free loan to the government! Conversely, underpaying your taxes can result in a big tax bill in April, and possibly penalties from the IRS for underpayment. To avoid these problems, strive to match the amount of income tax withheld as closely as possible to your actual income tax liability, adjusting your tax rates and allowances as your filing status changes.

Tax Form W-4 asks you to specify whether you want your taxes withheld at the single or married rate, how many withholding allowances you wish to claim, and whether you want an additional amount withheld from each paycheck. Claiming more allowances lowers the amount of taxes withheld, while claiming fewer allowances increases the amount taken at each pay period. Using the worksheets that accompany Form W-4 or the withholding calculator on the IRS website can help you determine how many allowances you are entitled to claim.

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If you have income from two different jobs, the IRS recommends that you complete only one set of Form W-4 worksheets or online calculations, and that you then split your allowances between the Forms W-4 for each job. Alternatively, you can claim all your allowances with one employer and none with the other. However, you cannot claim the same allowances with more than one employer at the same time.

If you are married filing jointly, and both you and your spouse are employed, calculate your withholding allowances using your combined family income, adjustments, deductions, exemptions, and credits — remember, joint filers should use just one set of worksheets or one set of calculations. While you and your spouse can divide your total allowances at your discretion, your family cannot claim an allowance twice. If, however, you and your spouse expect to file separate tax returns, you should each calculate your allowances using separate worksheets based on your individual income, adjustments and tax deductions.

When an event occurs in your life that affects your income tax liability, make sure to adjust your W-4 Tax Form to reflect the change. You can alter your withholding as frequently as you like by filling out a new Form W-4 and submitting it to your employer. Events that may require you to recalculate the withholding amount include getting married or divorced, having a baby, and buying a house. You may also consider adjusting your withholding tax if your spouse starts or stops working; if you or your spouse takes on a second job; or if you have new income from non-wage sources (such as an inheritance, unemployment compensation, retirement plan distributions, alimony, capital gains, interest, dividends, or gambling winnings).

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Changing your withholding is particularly important if your income rises dramatically or if an event occurs that lowers the number of allowances you are entitled to claim. In addition to the situations already mentioned, there are a number of other (less obvious) events that could lead to a decrease in the number of allowances you can claim. For instance, if you have been claiming an allowance for a dependent who is a qualifying relative or child, but you no longer expect to provide more than half of the dependent’s support for the year, resubmit your W-4. Similarly, if you have been claiming allowances for your anticipated tax deductions, but you now find they will be lower than you originally expected, a change in your withholding may be necessary.

Even if you do not realize that you have been underpaying your taxes until later in the year and you are now liable for interest and late fees, it is still not too late to adjust your W-4 Tax Form. Simply calculate the additional amount you expect to owe and give your new Form W-4 to your employer. Doing this will instruct your employer to withhold the extra amount from your remaining paychecks for the year. To correct any future discrepancies, file a new Form W-4 in January that accurately reflects your changed tax situation.

Finally, you may want to consider adjusting your withholding tax if you have received a large tax refund and anticipate no changes in your income tax liability for the coming year. Rather than overpaying the IRS over the course of the year, you could deposit that money into an interest-earning account/investment, use the additional income to pay off credit card debt, or increase your retirement plan contributions.