Withholding

Definition

Withholding refers to the portion of an employee’s wages retained by the employer for the purpose of automatically paying for various obligations such as federal and state income taxes, Social Security, Medicare, insurance premiums, pension contributions, union dues, and other required deductions. This practice ensures that employees meet their tax and other financial liabilities and helps prevent large, unexpected financial outlays when those obligations are due.

Examples

Federal Income Tax Withholding: Employers are required to withhold federal income tax from employees’ wages based on the information provided by the employee on Form W-4.
State Income Tax Withholding: Similar to federal income tax, state income taxes are withheld based on state laws and the employee’s Form W-4 or state equivalent.
Social Security and Medicare Taxes: Employers withhold a portion of an employee’s wages for Social Security and Medicare taxes, and they are required to match these amounts.
Health Insurance Premiums: If an employee elects to participate in a company-sponsored health insurance plan, the premiums can be automatically deducted from their wages.
Pension Plan Contributions: Employers may withhold a portion of wages to fund pension or retirement plans like a 401(k).
Union Dues: In unionized workplaces, employees’ wages may be deducted for union dues.

Frequently Asked Questions (FAQs)

1. Why is withholding necessary?

Withholding is necessary to ensure that employees fulfill their obligations for taxes and other financial responsibilities without having to make large lump-sum payments. It also simplifies the process for employees by spreading out payments over each paycheck.

2. How is the amount for federal tax withholding determined?

The amount for federal tax withholding is determined primarily by the information the employee provides on their Form W-4, such as their filing status and the number of withholding allowances.

3. What happens if insufficient tax is withheld from an employee’s paycheck?

If insufficient tax is withheld, the employee may owe a substantial amount when filing their annual tax return and may also be subject to penalties for underpayment.

4. Can employees adjust their withholding amount?

Yes, employees can adjust their withholding amount by submitting a new Form W-4 to their employer. This allows them to change their filing status, number of allowances, and additional withholding amounts.

5. How often do payroll taxes and other withholdings have to be deposited by employers?

Employers must deposit payroll taxes and other withholdings on a schedule that can be semi-weekly, monthly, or quarterly, depending on the size of their payroll and IRS requirements.

Gross Income: Total income earned by an employee before any taxes or deductions are withheld.
Net Income: Income received by an employee after all taxes and deductions have been withheld.
Form W-4: A form completed by employees to indicate their tax situation to their employer, which determines the amount of federal income tax to withhold.
FICA: Federal Insurance Contributions Act which mandates withholding for Social Security and Medicare taxes.
Payroll Tax: Taxes imposed on employers and employees, including federal income tax, Social Security, and Medicare.
Pre-Tax Deductions: Deductions taken from an employee’s gross pay before taxes are calculated, e.g., contributions to a 401(k) or health insurance premiums.

Online References

Suggested Books for Further Studies

“Payroll Accounting 2021” by Bernard J. Bieg and Judith A. Toland
“The Payroll Book: A Guide for Small Businesses and Startups” by Charles Read
“Income Tax Fundamentals 2021” by Gerald E. Whittenburg, Martha Altus-Buller, James E. Smith

Fundamentals of Withholding: Accounting and Payroll Basics Quiz

### What is withholding used for? - [x] Paying various taxes and deductions from an employee’s wages. - [ ] Providing bonuses to employees. - [ ] Employer's profit. - [ ] Employee's net salary. > **Explanation:** Withholding is the portion of an employee's wages retained by the employer to pay various taxes, insurance plans, pension plans, union dues, and other deductions. ### Which form do employees submit to adjust their federal income tax withholding? - [ ] Form 1099 - [x] Form W-4 - [ ] Form 1040 - [ ] Form 940 > **Explanation:** Employees submit Form W-4 to their employer in order to indicate their tax situation and adjust their federal income tax withholding. ### What type of tax is withheld under FICA? - [ ] Federal income tax only - [ ] State income tax - [x] Social Security and Medicare taxes - [ ] Property tax > **Explanation:** FICA withholding includes both Social Security and Medicare taxes. ### Withholding for which of the following does not affect the employee’s taxable income directly? - [ ] Federal income tax - [ ] Social Security - [x] Union dues - [ ] State income tax > **Explanation:** Union dues are withheld from an employee's wages but do not impact the amount of earned income subject to federal and state taxes. ### How can employees increase their withholding to avoid owing taxes at year-end? - [ ] Submit Form 1099 - [ ] Request less tax being withheld - [ ] Submit a new Form 1040 - [x] Submit a new Form W-4 for additional withholding > **Explanation:** Employees can submit a new Form W-4 to request additional withholding from their wages, thereby preventing them from owing taxes at the end of the year. ### Why might employees need to adjust their withholding periodically? - [x] Due to changes in personal or financial situations - [ ] It is required annually by the IRS - [ ] To avoid fines and penalties - [ ] Employer recommendation > **Explanation:** Employees might need to adjust their withholding periodically if there are significant changes in their personal or financial situations like marriage, divorce, or major income changes. ### How are withholding taxes deposited by employers? - [x] Based on a schedule set by the IRS, which can be semi-weekly, monthly, or quarterly. - [ ] At the end of the tax year only. - [ ] Upon employee's request. - [ ] There is no requirement for scheduled deposits. > **Explanation:** Employers are required to deposit withholding taxes based on a schedule set by the IRS which could be semi-weekly, monthly, or quarterly. ### What happens if an employer fails to deposit withholding taxes? - [ ] Nothing - [x] The employer may face penalties and interest charges. - [ ] The employee's wages will increase. - [ ] The IRS will cover the amount. > **Explanation:** Employers who fail to deposit withholding taxes can face significant penalties and interest charges imposed by the IRS. ### What defines the withholding amount for state income tax? - [x] State regulations and information provided on the employee's W-4 or its state equivalent. - [ ] The employer’s discretion. - [ ] Federal tax rules. - [ ] Employee’s financial advisor. > **Explanation:** The amount withheld for state income tax is defined by state regulations and the information provided by the employee on their W-4 or a state equivalent form. ### Who is responsible for matching the amounts withheld for Social Security and Medicare? - [x] The employer - [ ] The employee - [ ] The federal government - [ ] The state government > **Explanation:** Employers are responsible for matching the amounts withheld from employees' wages for Social Security and Medicare taxes as mandated by FICA.

Thank you for delving into the essentials of withholding with us. We hope the detailed overview and quiz questions helped you solidify your understanding of this critical payroll concept.