What is tax withholding?
Tax withholding refers to the amount of taxes that are deducted from your paycheck by your employer and paid directly to the government on your behalf. This helps ensure you don’t owe a large tax bill when you file your tax return.
Your employer calculates how much to withhold based on the Form W-4 you complete when you start a new job. This form indicates your tax filing status (single, married, etc.) and the number of allowances you want to claim. More allowances result in less taxes withheld from each paycheck.
The amount withheld is an estimate that aims to match, as closely as possible, your actual tax liability for the year. However, it’s difficult to withhold the perfect amount all year long. When you file your tax return, you’ll calculate your total tax obligation and reconcile it with the amount already paid via withholding. If not enough was withheld, you’ll owe additional tax. If too much was withheld, you’ll get a refund.
How is tax withholding calculated?
Your employer calculates how much federal income tax to withhold from each paycheck based on four main factors:
– Gross income (amount paid per pay period before taxes/deductions)
– Number of allowances claimed on Form W-4
– Tax filing status
– Pay frequency
The more allowances you claim and the lower your tax bracket, the less tax will be withheld. Your marital status also impacts your tax bracket thresholds.
The IRS provides employers with withholding tables that specify what percentage to withhold based on income level and filing status. Your employer essentially takes your gross pay, finds the corresponding withholding percentage, and deducts that amount.
For example, a single employee earning $4,000 per bi-weekly pay period could have 22% withheld for federal taxes, based on the 2023 IRS withholding tables. So $4,000 x 0.22 = $880 withheld from each paycheck.
Withholding allowances
When starting a new job, the most important factor in how much tax is withheld is the number of withholding allowances you claim on Form W-4.
Each allowance reduces your taxable income by a set value, thereby reducing your tax burden and amount withheld. For 2023, one federal allowance equals $4,650.
So claiming two allowances reduces your annual taxable income by $9,300 ($4,650 x 2). If you’re in the 22% bracket, that would reduce your annual federal tax by $2,046 ($9,300 x 0.22). That $2,046 would be spread out evenly over your pay periods.
Allowances account for personal exemptions, the standard deduction, and other tax deductions you may qualify for. So you can claim additional allowances if you expect to take a lot of deductions or have dependents. But be careful about claiming too many allowances. That could result in owing penalties when you file.
The Form W-4 now also allows you to have an additional flat dollar amount withheld each pay period. This is useful if you want a bit extra taken out to produce a refund.
How do I determine the right tax withholding?
Choosing the optimal number of withholding allowances and additional dollar amount to have deducted is part science and part art. The ideal is to have just enough withheld to avoid both owing taxes and getting a large refund. Here are some tips:
Use the IRS withholding calculator
The IRS provides a withholding calculator on their website that you can use to estimate your taxes for the year. You input details about your expected income, deductions, and credits.
It then suggests the number of allowances to claim and any extra withholding amount. This gives you a data-driven recommendation tailored to your situation.
Run the calculator whenever your circumstances change, like if you get married or have a child. Update your W-4 accordingly to avoid surprises at tax time.
Review your previous year’s tax return
Look at last year’s completed tax return to see how your total tax liability compares to what was withheld.
For example, if your return shows you owed an additional $2,000 on top of what was withheld, consider claiming fewer allowances. That will boost how much is deducted from each check and help cover what you owe.
Check a few years’ worth of returns to spot any trends. Do you consistently get large refunds? Then you may want to reduce your allowances. Do you keep owing money? Request additional withholding.
Adjust based on life changes
Major life events can substantially alter your tax situation and withholding needs. Getting married often means owing less in taxes, so you’d reduce your withholding. Having kids leads to tax credits and deductions, also generally allowing reduced withholding.
Conversely, if a spouse with an income goes back to work after caring for children, your household income may jump to a higher bracket. That could require boosting withheld taxes to avoid owing.
Be sure to submit a new W-4 to your employer after any major status or income changes. Don’t rely on old withholding settings.
Withhold at higher single rate if dual incomes
For married couples, a common approach is having the higher earner use the single withholding rate tables instead of the married ones. This prevents under-withholding when you have two incomes.
The married tax brackets are less than double the single brackets. So withholding at the single rate for one spouse generally gets the total amount withheld closer to the actual combined tax liability. Use the IRS calculator to dial in the optimal mix.
Check your paystub deductions
Glance at your paystub every few months to make sure your intended withholding allowances and extra amounts are actually being deducted correctly. Mistakes can happen.
Also look at the year-to-date totals to see if your on pace to have neither too much nor too little withheld based on your projected tax situation. Catch errors early and submit a new W-4 if needed.
Common percentage amounts withheld
While everyone’s tax situation is unique, here are some general guidelines and averages for amounts withheld from paychecks:
Federal income tax
– Single filers: 12-22%
– Married filing jointly: 12-22%
– Income over $250,000: 24-37%
The median federal tax rate is around 15% for most earners. Higher incomes above ~$170,000 (single) or ~$340,000 (married) fall in the top 24% bracket.
FICA taxes
The Social Security portion of FICA is 6.2% on the first $160,200 earned in 2023. Medicare is 1.45% on all earnings. Self-employed people pay both halves.
State income tax
State tax withholding ranges from 0% in states with no income tax up to 13.3% in the highest California bracket. Average statewide rates are:
– California: 6-8%
– Texas: 0%
– Florida: 0%
– New York: nearly 9%
– Illinois: just over 5%
Local taxes
Cities like New York City and Washington D.C. collect individual local taxes averaging 3-4% of income. Cities typically piggyback off the state withholding process.
Strategies to reduce how much is withheld
If you consistently get large refunds, you may want to reduce your tax withholding. Here are some options:
Claim additional allowances
Each allowance you claim on Form W-4 reduces your taxable income by $4,650, thereby reducing your tax liability and amount withheld. So claiming extra allowances can boost your regular take-home pay.
Just be careful not to go too far and owe penalties. The IRS calculator can recommend your optimal allowance amount.
Adjust your filing status
Tax withholding varies based on whether you file as single, married, or head of household. For example, the married brackets are wider than for singles, resulting in lower withholding at the same income levels.
So tying the knot could present an opportunity to reduce your withholding allowances and still break even or get a small refund.
Contribute to tax-advantaged accounts
Money you contribute pre-tax to retirement accounts like 401(k)s and IRAs reduces your taxable income. So increasing your contributions gives you access to those funds now while reducing current year withholding.
HSAs, FSAs, and childcare flex accounts similarly let you set aside pre-tax money. Maxing out those plans when possible can further lower how much tax is withheld from your pay.
Take above-the-line deductions
Charitable contributions, business expenses, moving expenses, and other above-the-line deductions reduce your taxable income, thereby reducing withholding.
Bunching charitable donations into one year or ramping up business expenses can create bigger deductions to lower how much is withheld.
Itemize deductions
Taking itemized deductions for mortgage interest, state and local taxes, and other qualifying expenses reduces your taxable income. This directly lowers the taxes withdrawn from your pay if your deductions exceed the standard deduction.
Get married
As noted earlier, getting married can open the door to claiming fewer allowances but still breaking even on withholding. You get access to the wider married brackets.
Just beware the “marriage penalty” at certain income levels and for some credits/deductions. Run the numbers carefully beforehand.
Withholding considerations by income level
Your income range impacts some special nuances to factor in when determining ideal withholding:
Low income
Those earning under ~$15,000 may have no income tax liability after the standard deduction and personal exemption. Submitting a W-4 claiming “exempt” can eliminate withholding.
Just be sure your situation qualifies. You don’t want to incorrectly claim exempt status and owe penalties.
Moderate income
Withholders in the 22-24% brackets (incomes from ~$55,000-$175,000) need to be most careful about getting close to perfect withholding. Too much or too little can surprise you at filing time. Run the IRS calculator annually.
High income
The IRS requires those earning over $150,000 to submit a new W-4 by February each year. At higher incomes, you want to closely track changes that could impact your tax bracket. Consider increasing withholding as your income grows to account for leaping into higher brackets.
Variable/inconsistent income
Those with fluctuating side gigs, bonuses, or irregular hourly pay may need to increase withholding to account for spikes pushing you into a higher bracket. Or estimated taxes may work better so you can pay in increments vs. waiting for withholding to catch up.
Consequences of not withholding enough
Withholding too little from your paycheck can lead to the following issues:
Owing penalties
If you owe more than $1,000 when you file your tax return, you may have to pay underpayment penalties. This applies if you paid less than 90% of the tax due for the year or 100% of the prior year. Penalties run around 0.5% per month.
Non-refundable credit loss
You must have a tax liability to claim non-refundable tax credits. Withholding too little could result in losing out on some credits.
Interest charges
The IRS charges interest on any tax underpayment, just like you would owe interest on an unpaid loan or bill. The rate is currently 6% but fluctuates quarterly. The interest clock starts ticking April 15.
Owing next year
Insufficient withholding this year makes it likely you’ll still owe next year after making estimated tax payments. It takes time for withholding to catch up based on your newly updated W-4 allowance claim.
Maximizing your tax refund
While getting a big tax refund isn’t the ideal outcome, some taxpayers purposefully boost withholding to forced savings. Here are ways to maximize your potential refund:
Claim fewer allowances
Claiming fewer withholding allowances on your W-4 is the easiest way to increase the taxes withheld from your paycheck and grow your refund. Just know it also reduces your take-home pay all year long.
Withhold at higher single rate
As mentioned earlier, having the higher earning spouse in a married couple withhold taxes at the single rate often produces a larger refund by withholding more in total from the two incomes.
Specify an extra dollar amount
Adding an extra dollar amount to withhold on the Form W-4 will boost how much goes toward your refund rather than into your pocket each pay period. Even an extra $20-$50 per check can make a difference.
Adjust status mid-year
If you claim married filing jointly status, you can change to just married (or even single) partway through the year to bump up withholding. Then switch back before December to file jointly.
Make estimated payments
Making estimated quarterly tax payments in addition to ongoing withholding allows you even more control over maximizing your refund. Boost your estimates to build up a refund.
Just be sure to avoid penalties by staying above 100% of prior year’s tax or 90% of current year’s.
Common withholding mistakes
Some common errors to avoid related to tax withholding:
Claiming too many allowances
While it’s tempting to claim extra allowances and boost your paychecks, claiming too many exemptions is one of the biggest mistakes. This can lead to owing penalties. Stick close to the optimal number.
Forgetting to update your W-4
Neglecting to submit a new W-4 after getting married, having children, or other major life changes is an easy pitfall. Update your withholding promptly upon significant events.
Not checking your paystub
It’s smart to periodically check that your intended withholding is actually being deducted from your pay properly. Don’t assume the numbers on your W-4 are being followed.
Withholding as married when both working
Having dual incomes can lead to under-withholding if you both claim married status. Using single rates for the higher earner often works better to maximize withholding.
Forgetting about bonuses/stock options
One-time bonuses, stock payouts and other irregular income also count toward your top tax bracket. Consider making extra estimated tax payments to account for spikes.
Frequently asked questions
How do allowances affect my taxes?
Allowances directly reduce your taxable income, which reduces the amount of tax withheld from your paycheck. Each federal allowance is tied to the standard deduction amount, so more allowances = less tax.
What percentage should a married couple withhold?
A married couple’s ideal withholding percentage varies based on their total income, deductions, credits, and number of jobs. Use the IRS calculator for an estimate. Married withholding is generally less than single at the same incomes.
How much federal tax should I have taken out of my paycheck?
There is no universal ideal percentage for federal tax withholding. It depends on your income, filing status, deductions and more. The IRS withholding calculator can provide a recommendation based on your individual details.
What happens if I don’t have enough taxes taken out?
If you didn’t have enough tax withheld, you will owe additional money when filing your return. You may also owe underpayment penalties if your withholding fell significantly short of your total liability.
Will I get a refund if I claim 0 allowances?
Claiming zero allowances on your W-4 will result in having more taxes withheld, but does not alone guarantee you’ll get a refund. You could still owe additional tax when filing. Use the IRS calculator to find your optimal allowance number.
Conclusion
Choosing the right tax withholding rate and allowances requires looking at your total income, tax situation, filing status, and prior year’s results. While there are general guidelines, use tools like the IRS calculator to dial in the optimal mix.
Update your W-4 anytime your circumstances change significantly. Review your withholding rate annually to avoid surprises at tax time. And you can tweak allowances if you want to target a refund or reduce how much you owe. But strive to have your withholding closely match your true tax obligation. That keeps more money in your pocket while avoiding penalties for underpayment.