As the name suggests, withholding taxes refers to the set amount of income that an employer withholds from an employee’s paycheck. Taxes withheld from a paycheck is taken as a credit against the employee’s income tax bill when taxes need to be filed. Join our experts at Founder’s CPA as we delve into more information on withholding taxes.
What is withholding tax?
For the majority of employed workers in the United States are subject to tax withholding, including nonresidents. Employers will remit these taxes directly to the IRS in the employee's name. In the situation that too much money is withheld, the employee will receive a tax refund; conversely, if not enough money was withheld, the employee may owe more to the IRS when filing taxes.
How it works
Why does tax withholding exist? It’s a method for the U.S. government to use a pay-as-you-go income tax system. The government is able to tax individuals at the income source rather than attempting to collect taxes after the payment has been made.
As soon as an employee gets paid, their employer will withhold a certain percentage of their paycheck as income tax. This amount is directly sent to the IRS. Employees can look at their pay stubs to see the amount that has been withheld. This annual amount can be found on Form W-2: Wage and Tax Statement. Employees receive their W-2s to file their tax returns.
In terms of the amount of taxes withheld, this depends on several factors. The IRS considers the amount of money an employee earns, filing status, withholding allowances that the employee claims, and whether the employee requests if additional income is withheld.
Special considerations
There are nine states that don’t charge an income tax on residents, including Alaska, Florida, New Hampshire, South Dakota, Nevada, Tennessee, Texas, Washington and Wyoming. In Washington, only high-earners on capital gains will need to pay withholding taxes. Residents in New Hampshire only pay income tax on dividend and interest.
Types of withholding taxes
The IRS uses two types of withholding taxes depending on the situation.
U.S. resident withholding tax
There are state laws in place that govern how much a company is allowed to deduct from an employee’s paycheck. If a company oversteps this limit, they could have a liability to any impacted employees.
Nonresident withholding tax
Nonresident withholding taxes apply to nonresident aliens to ensure proper taxes are paid. This refers to those who are not born in the U.S. and haven’t yet passed the green card test. They need to file Form 1040NR in the case that they’re participating in a trade or business in the U.S. at any point in the previous year.
Founder’s CPA offers personalized advice
If you’re looking for personalized guidance on the best way to approach your taxes or if you’re a business looking for more personalized advice, our team at Founder’s CPA is here to help. Contact us today to learn more about how we can help.
