Income tax withholding is when an employer withholds taxes from an employee's pay. Withholding tax is the amount deducted from an employee's paycheck before receiving it; the employer eventually pays those taxes to the appropriate taxing authorities.

Overview of the Tax Withholding System

In 1913, the Sixteenth Amendment to the Constitution was passed, allowing Congress to levy income taxes. Previously, federal revenue was generated principally through tariffs. A prior effort to collect taxes on income was established by The Revenue Act of 1961 but was repealed about a decade later.

In 1935, the Social Security Act was passed, establishing employers' requirements for Social Security taxes to be withheld. Congress later approved income tax withholding in 1943 in the Current Tax Payment Act. Since then, it has remained in place.

How Tax Withholding Works

Today, employers collect taxes before paying the employee. That means the person earning money does not receive their total gross income. Rather, the portion deducted for taxes is paid directly to the taxing authority. This helps to ensure payments are made. Employers are responsible for collecting the tax based on the estimated earnings of that wage earner. Then, the employer submits those taxes to the taxing authority, like the Internal Revenue Service (IRS), throughout the year.

The only income subject to income tax withholding is the wages you earn through your hourly or salary position. There are other ways to earn income, and it is still necessary to report that income in most cases. The difference here is that an employer is responsible for having to make the payment on behalf of the employee. To be clear, even if your income is not subject to withholding like this, you still are likely to have to pay those taxes, and it is up to you to calculate and remit payment for them.

Determining Your Federal Tax Withholding

How do employers know how much money to take from each person's paycheck? Dollar amounts are not the same for each person. Instead, it is based on how employees fill out their W-4 forms. Employers will use this form to determine how much tax to withhold based on laws and what the employee enters onto this form.

Completing Your W-4 Form

A W-4 form has five sections to fill out. The information on this form may seem complex, but it is easy to complete. The document provides instructions if there are questions on how to complete it. To complete the form, take the following steps:

1. Fill in your name, address, and Social Security Number. You will then need to fill out your expected filing status, such as married and filing jointly or single.
2. Include any other income earned from a spouse.
3. Write down any children or dependents that you have.
4. Provide information about any extra income or withholding you plan to make.
5. Sign it

The ultimate goal here is to ensure that 90% or more of your tax that is due in April of the year following is paid through your employer. If you do not provide accurate information and less than 90% of your taxes are paid by your employer, you may be subject to fines and penalties. The IRS and other taxing authorities want to be sure you are paying your taxes on time.

The key to completing the W-4 is including as much information as possible. There is no way to know what you will receive throughout the year, but the more accurate you can be when completing this document, the more likely you will not have to worry about reporting any fees or penalties later.