The Federal income tax works on a “pay-as-you-go” system that consists of two ways to pay as you go: withholding tax or estimated tax. Tax withholding forms the crux of this article.
Income tax will most likely get held from your salary by your employer if you work at a job. Incomes sources like commissions, bonuses, and pensions are also subject to being withheld from tax. Prior to funds being applied to your Social Security, Medicare, and income taxes for the year, the withheld tax is sent to the IRS on your behalf. The Form W-2 (Wage and Tax Statement) that you will get from your employer will contain that amount withheld in each category.
NOTE: Your State income tax is commonly withheld as well if you live in a state that decrees income tax.
How Is Withholding Tax Determined?
The amount of your salary and the information on Form W-4 (Employee’s Withholding Allowance Certificate) that you provide to your employer determines the amount of tax withheld from your regular pay.
Withholding Social Security Tax and Medicare Tax
Social Security and Medicare taxes are automatically withheld by your employer and have fixed rates. At present, the Medicare tax rate for the employer is 1.45% and for the employee is 1.45%, resulting in a total of 2.9%, while the Social Security tax rate is 6.2% for the employer and employee, with a total of 12.4%. There is wage base limit of $118,500 for Social Security tax for the year 2015.(In different terms, the maximum wage subject to Social Security tax for that year is $118.500.)
Withholding Federal Income Tax
The information you provide on Form W-4 determines the amount of Federal income tax withheld from your salary. Form W-4 needs to be filled out and given to your employer when you start a new job. A new Form W-4 must get completed, if at any point during the year, you need/want to make changes to your withholding tax.
Let’s say that you found out that excess or insufficient amount of tax was withheld last year, a new Form W-4 can be complete to adjust your withholding. Furthermore, particular life events like marriage, divorce, or the birth of a child can change the status of your filing or the number of exemptions you can claim. During such events, a new Form W-4 needs to be given to your employer in order to fix your withholding status and/or number of allowances.
Your employer will make use of three premier kinds of information on Form 2-4 in order to calculate your withholding tax:
- Whether to withhold at the “single” tax rate or the lower “married” tax rate is determined by your withholding status.
- The number of withholding allowances you claim (each allowance reduces the amount of tax withheld)
- If you want an additional amount to be withheld
Your employer will withhold less income tax, the more allowances for which you gain rights. A claim of zero allowances indicates that the most amount of tax will be withheld from your pay. IRS Income Tax Withholding Tables will be used by your employer to figure out the amount of Federal income tax to withhold for you, based on the status of your withholding and allowances.
In order to assist you in figuring out the number of withholding allowances that can be claimed by you, worksheets are attached to Form W-4.
What Happens If You Don’t Withhold Enough Tax?
After filing your return, you will get the overpayment as a tax refund if during the year you have excess amounts of tax withheld from your pay. You might be obligated to pay your Estimated Tax or have issues an underpayment penalty if you withhold too little tax.
Paying estimated tax may be required in case no tax is withheld from your pay or not enough payment is made through withholding. Customarily, you must pay estimated tax on a quarterly basis of 4 equal installments. Refer to What Is Estimated Tax & Who Does It Apply To? For further information.
If you don’t pay enough tax, either through withholding or estimated tax payments, you may be subject to a penalty for underpayment. According to the IRS, you could owe a penalty if your total payments (from withholding and estimated tax) do not equal at least 90% of your tax liability for the year, or 100% of your prior year tax, whichever is less.
You can get penalized for underpayment if not enough tax is paid through withholding or estimated tax payments. There are chances that the IRS can penalize you if your total payment, from withholding and estimated tax, is less than 90% of your liability in tax for the year or 100% of your tax due the year before, whichever is less.
Look up IRS Publication 505 (Tax Withholding and Estimated Tax) for further information.
Featured Image Source: DepositPhotos/© tashatuvango