How Withholding Tax Works

  • A withholding tax is a kind of income tax that works more like a sales tax. Under a traditional income tax you have to make a payment equal to a percentage of your income every year. Under withholding the government retains or withholds a percentage of payments you receive to cover your taxes.

    This tax is often called a payroll tax because it typically takes funds out of a person's salary. It can also be collected on interest, dividends and other forms of investment income. The idea behind withholding is to ensure that the government collects as much money as possible. In a traditional income tax system it is fairly easy for people not to pay. Under withholding the government collects the money as it is paid out.

    Pay as You Go
    Withholding is similar to sales tax because it is a pay as you go or pay as earn system. The tax money is taken out as person earns it so there is no return or paperwork. In some countries such as the United Kingdom and Australia most citizens pay their income tax through such an arrangement.

    The United States is different because it requires most citizens to pay both a traditional income and withholding. The federal government collects a withholding tax or FICA to finance Social Security and Medicare and an income tax. Many of the states also use a withholding tax to finance workman's compensation and unemployment insurance.

    The federal tax refund in the United States is usually withholding tax money that is paid back to taxpayers. The reason you have to send in W-4 forms from your employers with your tax return is to show the IRS that you worked and paid withholding during the year.

    You can figure out what your withholding tax is by looking at your pay stub. It should have amounts for Social Security and Medicare listed. These represent the FICA tax you paid. State withholding should be listed there as well. This is usually around 6% of your salary.

    Withholding Taxes and You
    There are some people in the US who will have to pay part or all their withholding themselves. This includes persons with more than one job and those that work as contractors and freelancers. Such people may need to pay Social Security and Medicare taxes along with their regular income tax. You will need to pay these taxes yourself if an employee did not send you a W-4 form.

    You can determine if you need to pay such taxes by checking the IRS's withholding tax calculator . This application can show you how much you need to pay and whether you need to create your own W-4.

    If there is no W-4 form filed with your tax return the IRS could decide that your employer did not pay your withholding and with that that amount from your income or tax return. Therefore you should always make sure that you have a W-4 for each of your employers before filing your tax return.

    Something to be aware of is that employers are required by law to provide you with a W-4. If this form is not sent to you, you should contact the employer and ask for one. If no W-4 is sent you can contact the IRS and complain. It is the employer's responsibility to send that form out.

    Source by Steven Hart

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