Employers should go to www.irs.gov and review:
- Publication 15 (Circular E), Employer’s Tax Guide;
- Publication 15-A, Employer’s Supplemental Tax Guide, and
- Publication 15-B, Employer’s Tax Guide to Fringe Benefits.
In the old days there was no withholding. When the government created income tax, you completed a tax return and sent a check. Guess what—not many people had the money to send.
Therefore, withholding was created as a “convenience” to the taxpayer and a huge responsibility for the employer. When the taxpayer did not respond appropriately, the government created penalties for underpayment of tax by appropriate time periods, i.e., if you do not have a percentage of your tax paid by December 31 either through withholding or estimated payments, you will pay a price for holding onto your tax dollars.
What Determines the Amount to be Withheld?
At your place of employment, your employer will require you to complete Form W-4, Employee’s Withholding Allowance Certificate, and Form G-4 for Georgia, Employees Withholding Allowance Certificate. All states with income tax have a similar form.
The form is designed for those people with only W-2 income and standard deductions. Based on the withholding tables, you record how many exemptions are deductions on your return and whether you are single or married. Your employer will then withhold the amount that corresponds to your wage level for the pay period and your number of allowances.
Depending on your situation (interest and dividend income, mortgage interest, children providing you with a tax credit, etc.) this may or may not be the appropriate amount to meet your tax obligation without penalty.
To review what is necessary to withhold or pay through estimated taxes without incurring a penalty, review the safe harbor rules in the tax article titled Estimated Taxes.
You can adjust the number of allowances at any time, and the number need not reflect the number of exemptions on your return. The allowances should reflect the amount of tax to withhold to break-even at the end of the year.
For instance, if this year will be similar to last year, you would take last year’s tax divided by the number of pay periods you will have. You would then adjust your allowances up or down until the appropriate amount is being withheld. You can review Publication 15, Employer’s Tax Guide, at www.irs.gov to see what a change in withholding exemptions will do at your pay level.
Form W-4 allows you to claim an exemption level and ask for additional specific dollars to be withheld. With some payroll departments you can simply ask for a certain dollar amount to be withheld without being confused by the exemption levels.
It is harder to arrive at an appropriate allowance level if you are married and both work. My recommendation is to leave one person’s alone and adjust the other. If you use a C.P.A. or tax preparer, they should be able to compute the appropriate allowance level for your situation.
You should keep in mind that if your total tax obligation for the year will be less than $1,000 it is not necessary to withhold or make estimated payments. You may pay your taxes by the following tax filing deadline without penalty.
You should also remember that the U.S. Treasury does not pay interest on the dollars they hold for you and return in the form of an overpayment when you file your tax return. Do NOT use over-withholding as a savings method. If your employer does not have a direct deposit payroll system that allows you to automatically put your savings dollars in a savings account, you can always make that deposit each pay period and earn interest all year.
Financial institutions are required to withhold federal tax on your interest, dividends, etc. if you do not supply them with a Form W-9, Request for Taxpayer Identification Number and Certification. This is referred to as backup withholding and is generally withheld at 31% of the taxable payments.
Pension administrators will provide Form W-4P, Withholding Certificate for Pension or Annuity Payments. You can elect no withholding, provide allowances or specify a fixed dollar amount to be withheld.
IRA distribution forms will ask you to elect no withholding, a percentage of the withdrawal or a fixed dollar amount.
If you would like further information regarding this topic or any other tax related issue, contact Henssler Financial at 770-429-9166 or [email protected].