The process through which your employee subtracts a portion of your income to the government is known as federal withholding. It is an estimate of how much taxes you owe to the government at the end of the year. The amount is divided by the number of pay periods- yearly, monthly, hourly or otherwise.
Your employer is obligated by law to withhold employment taxes. And it can also be taken from any other income of yours including pensions, bonuses or even winnings from gambling. This also includes your social security or Medicare amount. You will get a tax refund if too much of your money is withheld and an additional tax bill if too little is.
You might also want to read The Perks of Being a Tax Accountant
Why Did Federal Withholding Begin?
Withholding income tax from people’s wages is a fairly recent development. This was first introduced in the United States of America by President Abraham Lincoln to help capitalize on the Civil War. The current system was reinstated in 1943 when the government realized that collecting taxes becomes a strenuous process without getting them from the direct source. Every employee must fill out the W-4 Form that estimates how much money they owe to the government.
The W-4 Form, also known as the Employee’s Withholding Allowance Certificate, helps the employer determine the amount they should withhold from their subordinates based on their financial situation, marital status, and dependent individuals. Pre-tax deductions are removed from the total amount before the withholding amount is calculated. Taxpayers faced a huge burden when they had to pay the full amount of the money due on one date.
How Does Federal Withholding Work?
When the income tax was first introduced, people paid their tax bills for the previous fiscal year in quarterly installments or altogether in March. In the current taxation system, wage earners do not even see the money they owe to the government. The employers directly take it out of their pay and redirect it towards the federal government. The amount that will be withheld from every paycheck will be determined by the W-4 Form.
The information in this form is not conveyed to the government. But to the top-level managers of an enterprise so they can determine how much money to withhold. All you need to know is that irrespective of how the form is filled out. The tax due must be given to the government by March. You need to check whether the right amount of tax has been withheld. You can easily calculate this with the withholding calculator on the IRS website.
How is Federal Withholding Calculated?
Every federal withholding is different for individual employees. The federal tax withholding can be calculated either through the wage bracket method or the percentage method. The wage bracket method is less complicated than the percentage method. Employee wages must be thoroughly calculated for the latter. Dividends, interest or royalties must be included in this too.
A new W-4 form has been introduced for the 2020 tax year that adapts the changes implemented by the Tax Cuts and Jobs Acts. This change eliminated personal exemptions. Self-employed individuals are not required to pay federal withholding taxes but they must pay a quarterly payment instead.
What Happens When the Withholding Tax is Wrong?
If the withholding tax is incorrect, the taxpayer will face severe repercussions. They will find themselves paying more in income taxes or find themselves with a tax bill with interest or penalties. If the workers pay more, then the excess amount will be returned to the employee as tax refunds. You will not have to pay any federal withholding when you owe the government no income tax the prior year or the current year.
Can You Change Your Withholding Amount?
You can easily adjust your W-4 for during the tax year by simply correcting the errors and submitting a revised form to your employer. It is advisable that you submit a new form when you experience a major change in your life such as the birth of your child, a marriage or a divorce.
What Are the Merits of This System?
You do not have to worry about saving up an enormous amount of money to pay to the government at the end of the year. Tax withholding allows you to make affordable and bearable payments throughout the year instead of a bulk amount at once. You only pay close attention to your transactional money you make so you do not notice the missing money until you check the tax returns for the year. And since the tax is withheld from every paycheck you get, you might think the amount is not as large as you think it was.
Tax withholding removes the opportunity for tax evasion. Tax evaders are unable to keep their money from the government’s hands. This policy ensures the government will receive all the taxes in its due time. There is also a significant decrease in collection costs. The government does not have enough manpower to collect all the taxes and then go after the unpaid ones. The faster the government receives money, the sooner they can start initiating the programs they planned on funding.
The taxes you pay are the government’s main source of earnings. This fund is then used by the government to invest in education, subsidies, technology, and development. The government primarily spends on health programs, safety net programs, social security and finally defense and security.
Safety net programs include insurance for the unemployed, assistance for those with no housing or programs to help orphaned or abused children. They also pay to improve transportation or infrastructure or alleviate the balance of accounts deficit.
The tax withholding system exists because the government wants to finance projects that will benefit society. If you can understand the mechanisms of the system, you will know where the money you earned is being invested in.