What Is Withholding?

Withholding is the portion of an employee's wages that is not included in their paycheck but is instead remitted directly to federal tax authorities and, where applicable, state and local tax authorities.

The employee's income, marital status, number of dependents, and number of jobs all determine the amount withheld. These facts are recorded by the employee on a W-4 form supplied by the employer.

Withholding is an estimate of the taxes the employee will owe. American taxpayers file an annual tax return in order to record their actual income from all sources for the full year and the amount they have already paid. This, in addition to any deductions they claim, determines what they actually owe for the year and triggers either an additional payment or a refund of overpaid taxes.

Understanding Withholding

In the United States, all income earners are obligated to pay income tax to the federal government. Most states have income taxes as well, and a few counties and cities levy resident income taxes.

Employers are required to withhold tax from employees' paychecks to ensure that they consistently pay their income taxes. Employers remit the tax collected to the Internal Revenue Service (IRS) on behalf of the wage earners.

Form W-4

An employee who starts a new job must fill out IRS , which the employer typically provides. For example, the employee must indicate whether they have one or multiple jobs. If they have multiple jobs, they must disclose how much is earned from the other job(s).

The employee is also expected to divulge their marital status. If married, they are asked whether the spouse is employed and how much the spouse earns.

Form W-4 also includes questions about dependents and filing status, such as a head of household or married filing jointly. The remaining section of the form is filled out by the employer.

The employer uses the information provided by the employee to calculate the amount of tax to withhold from the employee’s pay.

Any new event that unfolds in the employee’s life, such as a change in marital status, an additional dependent, or a new job, would require the employee to fill out a new W-4. The employer uses the new information to re-evaluate the portion of income to withhold for tax purposes.

Special Considerations

If the tax withheld is inaccurate, the taxpayer has to pay more or less when tax filing season arrives. If the employee paid too much, the IRS will refund the excess. Workers who end up not paying enough tax on earned income may be subject to late-payment penalties and interest.

Self-employed workers aren't subject to withholding but must pay their income taxes, usually as quarterly estimated tax payments. Taxpayers may also have to make estimated tax payments if they receive substantial income in the form of dividends, capital gains, interest, or royalties.

Federal Withholding vs. State Withholding

Withholding is generally classified as federal withholding or state withholding.

Federal withholding is the amount withheld from wages for taxes owed to the federal government. The amount of withholding is based on filing status, the number of dependents, certain adjustments to income, and other personal withholding preferences selected on Form W-4. Wage-earners can also elect to have a specific amount withheld in addition to what's calculated from elections. They can also elect to have nothing withheld by claiming an exemption.

Federal withholding includes amounts paid into the Social Security and Medicare funds. The employee and employer are responsible for paying an equal share of these taxes. From the employees' pay, 6.2% is withheld for Social Security and 1.45% for Medicare. The employer pays a total of 7.65% on the employee's behalf.

State withholding is the amount withheld from wages for taxes owed to the taxpayer's state of residence. In some cases, the taxpayer may owe taxes to multiple states. For instance, if a remote worker splits their time between two residences in different states, they may owe taxes to each state. It may be possible for an employer to withhold taxes for each state.

Other Types of Withholding

Employees who have retirement accounts through their employers have their contributions withheld from their paychecks.

Employees who have traditional retirement accounts rather than Roth accounts do not pay income tax on their contributions. That is, they are paying in "pre-tax" dollars and will owe income taxes on that money only when they withdraw it. That, by the way, reduces their income for the year and the amount of tax that is withheld from their paychecks.

Employees who have Roth accounts pay the income taxes on their contributions up front. That is, they pay taxes on their full income but pay in a portion to the retirement account. They should owe no further taxes on that money when they withdraw it.

The Bottom Line

Withholding is the amount deducted from wages for taxes: federal, state, or local. All wage-earners in the U.S. have federal taxes withheld. Most have state taxes withheld and some have local taxes to pay as well. If more than enough taxes are withheld throughout the year, the taxpayer will receive a tax refund after filing an annual tax return. If withholding is insufficient, the taxpayer is obligated to pay the remaining tax obligation. Employees must complete a form W-4 to indicate what should be withheld for taxes based on their personal situation. The IRS provides a that taxpayers can use to estimate how much they should withhold.