Employers and employees are affected by tax withholding regulations set by the federal government, as well as state and local regulators. Withholding includes mandatory deductions and voluntary deductions requested by the employee.
What is tax withholding?
For employees, withholding is the amount of federal income tax withheld from your paycheck. The amount of income taxes your employer withholds from your regular pay depends on two things:
The amount you earn.
The information you give your employer on Form W–4.
For help with your withholding, you may use the Tax Withholding Estimator. The Tax Withholding Estimator compares that estimate to your current tax withholding and can help you decide if you need to change your withholding with your employer for the next tax season.
Further reading: The Role Of Withholding vs. Deductions In Your Taxes
Who is responsible for tax withholding?
Your employer is responsible for the remittance of your income taxes to the Internal Revenue Service. This is done on a monthly basis as a payroll deduction before you receive any income.
Most taxpayers are subject to withholding unless they can prove that they owe no federal, state, or local taxes in the current tax year and are unlikely to owe any taxes in the next tax year.
Taxpayers should be certain that this is a true reflection of their tax situation before instructing their employer not to withhold taxes.
The burden of accurate tax withholding falls on an employer. Payroll and withholding mistakes cause reputational damage to employees, so if you don’t have proper bookkeeping processes in place to ensure accurate withholding, speak to Hall Accounting Company today. We will quickly and efficiently set up all the processes you need.
7 Advantages of income tax withholding
Withholding has several advantages for the taxpayer, even though the employer is responsible for administering the remittance of the taxes. It has largely been seen as a positive initiative because it takes the burden of paying a lump sum in taxes away from the taxpayer. Here, we discuss seven of those advantages:
1. Prevents tax bill shock
The primary advantage of withholding is that it prevents salaried individuals from facing a large tax bill when they file their returns. Spreading out the tax liability over twelve months may seem like a huge burden on monthly income - especially when you start to think about all the things you could do with that money.
But, speak to any self-employed individual who has received a nasty shock at tax time. You’ll hear them say they long for the days when they did not have to worry about saving for taxes or being blindsided by a huge tax bill.
2. Ensures compliance with IRS regulations
At a time when the spotlight has been cast on where American taxpayer dollars are being used, it’s tempting to feel uneasy about handing over your money. But there’s no escaping tax responsibilities, and withholding provides the peace of mind that you’re complying with federal tax regulations. This ensures you stay well clear of incurring penalties and interest for non-payment.
Withholding ensures that you comply with Social Security tax and Medicare tax, which are seen as important contributions to American social initiatives.
3. Avoids penalties and interest
Related to compliance, avoiding penalties and interest stands on its own as an advantage to withholding taxes. Mistakes can happen even if your employee collects taxes, but they are more likely to result in penalties and interest when you file your taxes yourself. The biggest reason for this is a lack of understanding or the misapplication of deduction rules.
Penalties and interest can be quite brutal depending on the reason for non-compliance, which can sometimes lead to an audit and even the charge of a fraudulent return. Withholding prevents this for the majority of taxpayers.
4. Automatic and convenient
If you’ve always had your taxes withheld by your employer, perhaps the stressful experience of quarterly submissions and an unexpected tax bill isn’t something you’ve had to think about. This is exactly why automatic withholding is advantageous.
You don’t need to think about whether you owe money after payday, and you can enjoy your hard earned cash knowing you don’t personally have to make an IRS payment.
5. Spending safeguard
Since tax payments are taken before employees receive their pay, it prevents people from accidentally spending money that should have been set aside for taxes. One can imagine the effect even if only 30% of the 100 million taxpayers couldn't meet their tax obligations if taxes weren’t collected throughout the year.
6. Can result in a lump sum refund
This isn’t something that the IRS prefers (because it causes an administrative burden), but if too much tax has been withheld, you may receive a tax refund. When filing your tax return, the IRS will notify you if you are eligible for a refund.
However, they will also request that you review the W-4 form that you submitted to your employer to ensure you pay the correct taxes in the next tax year.
7. Saves community initiatives
Withholding is a way for the government to collect taxes at its source, instead of waiting for the taxpayer to make estimated tax payments after they’ve been paid. During World War II, the federal government introduced payroll withholding as a solution to the difficulty of collecting taxes. At the time, money was urgently needed for rebuilding and redevelopment efforts.
Withholding has stuck around to this day, where the government requires a steady income stream to fund national, state, and local social initiatives. Without it, many communities will not get the funds they need to keep clinics, schools, rehabilitation facilities, libraries, and other institutions going.
6 Disadvantages of income tax withholding
As advantageous as withholding is for the American taxpayer, there are some disadvantages worth mentioning. These disadvantages speak mainly to lost income and the complexities of difficult withholding scenarios.
1. Lost monthly income due to over-withholding
One of the biggest complaints that individual taxpayers have is over-withholding. The vast majority see the possibility of this as devastating to their day-to-day quality of life. Yes, sure, it’s great when you can get a refund, but most people prefer to have guaranteed monthly income that they can utilize for living expenses.
The IRS strictly monitors this to prevent it from being a pattern and requires that all employers ensure accurate remittance of payroll taxes.
2. Potential for under-withholding, non-payment, and surprise tax bills
Under-withholding is many times the result of an erroneous W-4 form received from the employee. For this reason, the IRS places the obligation to ensure the correct withholding of taxes largely upon the taxpayer. Of course, there are exceptions to this, like when an employer fails to remit taxes after collecting them from their employees.
The downside of under-withholding is learning that you need to pay taxes at tax time, especially if you had no idea this was coming. It places taxpayers in a bad position, and often, people do not have the funds to make additional payments. However, it will only happen once in most cases because employees are quick to rectify errors when they realize the consequences of rushed W-4 submissions.
3. Lack of flexibility
Once withholding is set, changes often require submitting a new W-4 form, and adjustments may not be immediate. Tax professionals are the best people to advise you on your options if you find you’ve made an error and want to know how quickly you can rectify it.
4. Complexity across multi-income households
For individuals with multiple jobs or other sources of income, ensuring the correct amount is withheld across all sources can be challenging.
Example:
Sarah and James are married and file their taxes jointly. Both work full-time jobs, and they also earn rental income from an investment property.
Each of their employers withholds taxes from their individual paychecks based on the assumption that their salary is their only source of income. However, because they have a second income (rental property), their total household income is higher than what their employers’ withholding calculation assumes.
It is likely that Sarah and James will owe outstanding taxes at the end of the tax year.
5. Difficulties of withholding state and local taxes
State and local withholding rules vary widely, making it difficult for employers to ensure accurate deductions. Employees working remotely or across state lines may face unexpected tax liabilities or need to adjust withholding accordingly.
6. Does not include tax deductions or credits in real-time
Withholding is often based on standard assumptions and may not reflect personal deductions, credits, exemptions, or life changes until tax filing time.
For instance, a common tax credit is the child tax credit for each qualifying child who has a Social Security number that is valid for employment in the United States. This tax credit is only claimed when you submit your tax return (along with other tax credits), and its benefits do not impact your monthly take-home pay.
Withholding - a taxpayer’s income tax friend
During this discussion, we’ve compared the advantages of withholding with the disadvantages and concluded that the benefits still outweigh any negatives. Withholding provides the security and stability that most taxpayers need when it comes to dealing with their taxes, and it provides certainty as to how much money you have to live off.
This is what most people need.
If you’re an individual or business and are having any problems with your tax withholding, give Hall Accounting Company a call now. Let us help you sort out what’s causing your problems so that you can get back on track as soon as possible.
Our tax associates are waiting for your call.