A withholding allowance determines the amount of money that taxpayers pay the Internal Revenue Service during a calendar year from their paychecks. If a taxpayer asks their employer to withhold too little money, they may owe a large tax payment at the end of the year; too much, and they may have a larger-than-expected tax refund.
A withholding allowance determines the amount of money from each paycheck that an employer sends to the IRS on behalf of an employee. If employees ask for too little money to be withheld, they can owe a large tax payment. If an employee asks for too little money from a paycheck to be withheld, they're effectively loaning money to the IRS at 0% interest.
What is a withholding allowance?
Employers are required to withhold money from their employees and pay Social Security, Medicare, and income taxes to the federal government. Employees don’t have anything to do with the amount of Social Security or Medicare taxes withheld, but they do have some control over how much of their paycheck is used to pay federal income taxes.
The amount that’s withheld by the employer during a calendar year often doesn’t become an issue until the next year. If too much is withheld, the employee can be owed a big refund from the government, which has basically benefitted from a loan. If too little money is withheld, the employee can be stuck with a big tax bill.
Form W-4 and Withholding
Although employers are responsible for sending money from each paycheck to the federal government, the amount that’s held back can be influenced by the employee via a W-4 form. The W-4 is generally at or near the top of the stack of paperwork that employees will fill out when they start a new job.
Completing a W-4 form should only take a minute or two. It’s a five-step process:
- Personal information, including name, address, Social Security number, and filing status (single or married, filing separately; married filing jointly or surviving spouse; or head of household).
- Inform the IRS if you have more than one job or if you’re married, filing jointly, and your spouse also works. Use the worksheet on page three of Form W-4 to calculate any additional withholding.
- Claim dependents if your income is less than $200,000 (or $400,000 if married, filing jointly).
- Add other adjustments, such as other income, possible deductions, and extra withholding. Use the worksheet on page three of Form W-4 to calculate additional deductions.
- Sign and date.
Calculating your W-4
Like any other tax question, calculating your amount of federal withholding is far from simple. The easiest method is to use the IRS Tax Withholding Estimator tool. You’ll need your pay stubs (and any from your spouse), information on other income, such as side hustles, investments, etc., and your most recent tax return.
You’ll need to know the following:
- Your filing status.
- Your taxes withheld to date.
- Any planned adjustments, such as student loan interest, moving expenses, alimony, or individual retirement account (IRA) contributions.
- Whether you’ll take a standard deduction or itemize your deductions and the amounts of each itemized deduction.
- Any tax credits you might be eligible for, such as education, child and dependent, mortgage interest, energy-efficient vehicles, etc.
The tool will tell you how much you’ll need to withhold to get a refund (or pay taxes), along with your standard withholding amount. It also allows you to tailor the amount of withholding to get a desired refund or make a year-end payment.
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Changing Your W-4
The days of keeping the same job for decades are all but over for most Americans. The average person changes jobs every two years and nine months, according to one estimate. But even if the salary for your new job is the same (or relatively unchanged), you should check your withholding.
A job change isn’t the only reason for recalculating your withholding amount. If you get a second job -- like one in 20 American workers -- you need to take another look at your withholding. You should do the same if you get laid off or become unemployed for part of the year, get married or divorced, or have another child. Also, make the same calculations for your spouse.
Filing your annual federal income taxes can be an incredibly stressful exercise. Careful planning can significantly decrease your stress -- and save you money.
