The exact amount withheld from your pay depends on several factors, such as income, deductions, and relevant tax rates. While tax withholdings are intended to match how much you’ll owe when you file your taxes, the amounts may not always align perfectly. With a paycheck, for example, your employer typically asks you to complete a W-4, which is a form that calculates what your withholding will be. This form will let you specify things like your number of dependents, which helps determine how much your employer should withhold. For example, if you have children you claim as dependents, you could add that information to your W-4 to reduce your tax withholding. However, if you don’t claim any dependents, you could be eligible for a tax refund because your withholdings were more than what you owed. On the flip side, if you claim more deductions on a W-4 than you’re entitled to, you might receive a higher paycheck, but could end up owing taxes and/or have to pay penalties. If you’re a freelancer who isn’t an employee, you generally won’t have paycheck withholdings. You’ll need to set aside money on your own through estimated tax payments. That way, you can meet your tax liability throughout the year, rather than owe penalties and be hit with unexpected bills during tax-filing season.
Example of a Tax Withholding
Suppose you earn $2,000 per pay period. Instead of receiving $2,000, you receive a paycheck for $1,600, because your employer has set aside $400 as a tax withholding. For the year, you pay $10,400 in withheld taxes. When you file your taxes, you find out you only owe $6,000, so you get a $4,400 refund. The following year, you reduce your tax withholding so that you get a bigger paycheck while setting aside just enough money to cover your taxes instead of overpaying like you did the year before.
What a Tax Withholding Means for Individuals
Understanding tax withholding is important when it comes to your tax management and budgeting. If you don’t fill out your W-4 form accurately, for example, you might receive a higher paycheck and spend more money, only to have a big tax bill later on that you can’t afford. Or, you might consider intentionally having more withheld from their paycheck so they end up with a tax refund after they file. However, you may want to consider other saving strategies, such as depositing a small amount from each paycheck into an interest-bearing bank account.
