Withholding and deductions are two terms used to describe different functions in the tax system. Withholding is a method used by employers to remit taxes on behalf of the employee to the IRS, and deduction is a tax break given to taxpayers that helps reduce federal income tax.
Here in the United States, taxpayers and businesses have an obligation to educate themselves about the various tax regulations, including the concepts being discussed here today. While both withholding and deductions impact the amount of taxes paid, they play a different role within the tax system. Understanding the differences will help you avoid compliance issues and reduce taxable income.
Before we begin, if you’re a small business that’s rapidly expanding and struggling to keep up with payroll and withholding regulations, Hall Accounting Company is a fully fledged accounting and taxation firm that can help. Our clients have received the freedom to do what they love by passing on their accounting and tax functions to us, and you can, too!
What is tax withholding?
Tax withholding refers to the portion of income that an employer, financial institution, or other payer deducts and remits to the IRS on behalf of an individual. This system ensures that both federal income tax and state income tax are collected systematically throughout the year, rather than in a lump sum at tax time. This provides the federal government with a steady stream of income throughout the fiscal year.
Taxes are deducted from gross pay as payroll deductions, along with other contributions. The amount left after this is called net pay (take home pay). There are a number of both mandatory deductions (required by law) and voluntary deductions (requested by the employee) that qualify for withholding.
This usually applies to: Salaried employees and certain types of independent contractors.
Key regulations governing tax withholding
Employers are required to withhold a number of mandatory taxes by federal law. Here are the four mandatory taxes that are deducted from the payroll.
Mandatory Tax | Description |
Federal Income Tax Withholding (FITW) | Under the Internal Revenue Code (IRC), employers must withhold federal income taxes based on employee provided details on the W-4 form. |
FICA taxes | Employers withhold Social Security and Medicare tax under the Federal Insurance Contributions Act (FICA). The current rate is 15.3% of earnings, split between the employer and employee. An additional 0.9% is withheld for employees earning more than $200,000. |
Tax up to 22% is withheld on any bonuses, rewards, incentives, and commissions. | |
State and local income taxes | Many states impose their own withholding requirements, which employers must comply with in addition to federal laws. |
Voluntary payroll deductions
Voluntary deductions employees can request to be withheld from their paycheck to cover specific benefits or contributions. This includes health insurance premiums, retirement deductions (like a 401(k)), charitable donations, or flexible spending account (FSA) contributions. Employees must give written consent to their employer on the W-4 form to make these deductions.
What is a W-4 form?
All employees entering the workplace for the first time or changing jobs, are asked to fill out a W-4, Employee’s Withholding Certificate. This form tells employers how much money to withhold from salary or wages in a pay period.
Ultimately, employees are responsible for the information on the W-4, which employers use to withhold the correct taxes. If you’re unsure about taxes that must be withheld, the IRS provides a tax withholding estimator.
What happens if the incorrect taxes are withheld?
If the withholding amount deducted is more than you actually need to pay at the end of a tax year, you will receive a tax refund. Similarly, if the amount withheld is less than the taxes you owe, you will need to pay the outstanding taxes when you file your tax return.
Most employers have accounting systems to help them withhold taxes correctly so that employees do not have large tax bills to pay when tax season arrives.
If you suspect you’ve made errors on your W-4 form, causing tax withholding problems, Hall Accounting Company can help. Our highly skilled tax associates will review your information and assist you in making corrections. Call us today.
What are tax deductions?
Tax deductions are allowances by the federal government, allowing taxpayers to reduce their taxable income, thus lowering taxes owed. Unlike withholding, which is taken before income is received, deductions are claimed when filing a tax return and are the sole responsibility of the taxpayer.
Usually applies to: self-employed, independent contractors, freelancers, and businesses.
Key regulations governing deductions
A deduction is subtracted from your income when you file your tax return and are governed by strict tax regulations.
Allowable Deduction | Description |
Standard vs. itemized deduction | Taxpayers may choose between a standard deduction (a set amount determined annually by the IRS) or itemized deductions, which include specific expenses like mortgage interest, medical costs, and charitable deductions. Non-residents and partial-year filers cannot take the standard deduction. |
Business deductions | The IRS allows businesses to deduct ordinary and necessary expenses, including wages, rent, and depreciation. |
Above-the-line deductions | Certain deductions, such as student loan interest and HSA contributions, reduce taxable income even for those who take the standard deduction. |
State and local tax (SALT) deduction | Taxpayers who itemize can deduct state and local income, sales, and property taxes, though the deduction is capped at $10,000 for individuals and married couples filing jointly. |
How do you claim itemized deductions?
Whereas a standard deduction is a flat rate based on your filing status, itemized deductions are based upon actual expenses that you wish to claim on Schedule A (Form-1040). You should claim itemized deductions if the total of these deductions exceeds the standard deduction allowable by the IRS.
Examples of tax deductions
Mortgage interest deduction - Mark and Lisa own a home and pay $10,000 in mortgage interest annually. By itemizing deductions, they can reduce their taxable income by this amount.
Self employed business expenses - Emily runs a small marketing business from home and spends $5,000 on office supplies and software. She deducts these expenses from her business income, lowering her overall tax bill.
Self-employed and small businesses often leave money on the table by not claiming allowable deductions. Don’t let this happen to you when you can reduce your taxable income. Call Hall Accounting Company today and let our tax associates work with you to save your hard earned money.
Withholding vs. deductions: Key differences
The terms withholding and deduction are sometimes used interchangeably, but there are key differences between these concepts and the role they play in your taxes.
Feature | Withholding | Deductions |
Timing | Taken before income is received | Applied when filing an annual tax return |
Purpose | Prepaid tax collection | Allowable tax breaks |
Application | Employers, taxpayers, financial institutions (interest and investments) | Taxpayers and businesses |
Impact on income | Withholding ensures that taxpayers do not have to pay a lump sum at tax time that they might not be able to afford. Higher withholding may lead to a refund. | Higher deductions reduce taxable income, lowering tax liability. Taxpayers must make allowances during the tax year for the payment of taxes. |
It’s safe to say that if you want to achieve better tax financial outcomes and compliance with IRS regulations, it’s important to distinguish between withholding and deductions.
Educating yourself on basic tax regulations empowers you to take hold of what is yours and make use of every avenue afforded by the government to reduce your tax liability. It also empowers salaried workers to make decisions about voluntary deductions for contributions that can benefit their retirement or medical savings.
You can view it like this: Everything you don’t know is a lost opportunity to save money.
Don’t allow a situation where you pay more taxes because you’re not sure what you can and cannot do regarding deductions and withholdings. Take charge now by consulting with tax professionals who can not only help but also empower you in the long run. Call Hall Accounting Company. We are ready to help.
Final thoughts
Whether you’re an individual taxpayer, self-employed, or small business owner, we’ve all felt that sense of uncertainty (and sometimes dread) about important things we don’t understand fully. Tax is on top of that list, especially because most people are aware that non-compliance or tax mistakes can be very costly, both to your pocket and your reputation.
Taking small steps to educate yourself on the various applications of withholding and deductions can make a huge difference to your tax bill each year, and we highly encourage all our readers to do this. You don’t have to be in the dark about tax laws while we’re a phone call away.