Glossary of Human Resources Management and Employee Benefit Terms
Withholding is a portion of an employee’s wages that is left out of their paycheck. This portion is paid to the federal, state, or local tax authorities. An employee’s earned wages along with the amounts withheld are shown on the W-2 Form they receive at the end of the year.
Withholding minimizes the amount of taxes employees have to pay when they submit their annual tax returns.
In the U.S., all income earners are required to pay income tax to the federal government and some state governments. This withheld tax money is used to enhance the wellbeing of residents through health, education, Social Security, and food and agriculture sectors.
Tax authorities require employers to withhold a portion of their employees’ wages to ensure that all working residents are paying their income taxes. Employers send this collected tax money to the Internal Revenue Service (IRS).
Individuals who begin a new job must fill out a W-4 Form for their employer. A W-4 ensures that income and withholding are calculated correctly on the employer’s pay. This involves providing information such as income, marital status, number of dependents, and number of jobs. These components will determine the amount withheld.
Non-residents—those who were not born in the U.S. and do not meet the requirements in the green card test or substantial presence test to be considered a resident for tax purposes—must fill out a Form 1040NR if they are involved in a trade or business in the U.S.
To calculate withholding, you will need an employee’s:
W-4 Form or 1040 NR. Ensure that all relevant information has been provided by the employee.
Payroll period details. Find out the frequency of the employee’s pay periods (weekly, biweekly, or monthly).
Adjusted gross pay for the pay period. This would be the total amount paid during their pay period in salary or wages.
You’ll then need to choose a calculation method. There are two options:
Wage bracket method. This involves using the IRS tax tables to determine the employee’s wage range. You can find these tables in the updated 2020 Publication 15-T with instructions and worksheets to walk you through the calculations.
Percentage method. If an employee’s taxable wages exceed the last bracket of tables, then you must use the percentage method. Generally known to be more complex than the wage bracket method, this entails using formulas that are included in the Publication 15-T linked above. There are separate instructions and worksheets based on whether you use an automated payroll system or a manual payroll system.
The IRS also recommends using their Tax Withholding Estimator to make sure you are withholding the right amount of tax withheld from your employees’ paychecks.
Withholding taxes are generally non-refundable. But if there has been an error made in the calculation and/or too much money is withheld, then a refund will be issued to the employee.
Before 2020 the average withholding from a paycheck was determined by how many withholding allowances an employee claimed. In 2019 the value of a withholding allowance was set at $4,200, as reported by Bloomberg Tax. Each withholding allowance would reduce the amount withheld per pay period as follows:
Because of changes for 2020 Form W-4 in 2020 no longer uses personal allowances. Instead, people earning $200,000 or less ($400,000 or less if married filing jointly) multiply the number of dependents under age 17 by $2,000, and other dependents by $500, and add up the sums to get the amount that will be used to adjust withholding based on dependents.
Employees who have already completed a Form W-4 before 2020 are not required to file a new form, and employers will continue to use the information from employees’ most recent Form W-4 to figure withholding.