What Is a Withholding Allowance?
A withholding allowance is an exemption that reduces how much income tax an employer deducts from an employee’s paycheck and transmits to the IRS on their behalf. The allowance is tied to the personal exemption, a federal tax break that was available to all taxpayers, regardless of their expenses, through 2017.
The Tax Cuts and Jobs Act of 2017 eliminated personal exemptions between 2018 and 2025. As a result, the withholding allowance has no current practical relevance, but that could change in 2025. For now, it is no longer used on Form W-4: Employee’s Withholding Certificate, which the Internal Revenue Service (IRS) completely redesigned and that employees in the United States fill out and submit to their employers so their employers know how much to withhold from workers' paychecks.
Key Takeaways
- A withholding allowance is an exemption that reduces how much income tax an employer deducts from an employee’s paycheck. It is linked to personal exemptions, federal tax breaks for all taxpayers.
- With the passage of the Tax Cuts and Jobs Act (TCJA) of 2017 and the elimination of personal exemptions, withholding allowance became moot.
- Before 2018, withholding was based on the number of allowances a taxpayer claimed for themselves, their spouse, and their dependents, as well as their tax filing status.
- With the TCJA, changes to the standard deduction amount and Child Tax Credit may offset at least part of the change brought about by eliminating personal exemptions for most families.
- Internal Revenue Service (IRS) Form W-4 is used to calculate withholding. Individuals should file a new Form W-4 whenever their personal or financial situation changes.
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How Withholding Allowances Worked in the Past
Before 2018, an individual was required to fill out Form W-4, which included personal information, such as their name and Social Security number, when hired by an employer. The form also included the number of allowances to be made.
Once the information was completed, the employer used the W-4 information to determine how much of an employee’s pay to subtract from their paycheck to remit to the tax authorities. The total number of allowances claimed was important—the more tax allowances claimed, the less income tax would be withheld from a paycheck;the fewer allowances claimed, the moretax would be withheld.
The withholding amount was based on filing status—single or married but filing separately, married and filing jointly, or head of household—and the number of withholding allowances claimed on the W-4.It was important to determine the right number of allowances to claim to avoid trouble when filing taxes or to keep from giving the government an interest-free loan by paying too much in taxes only to receive the amount back later.
How to Calculate Withholding Post-2017
Much of how things worked before the passage of the TCJA is the same today. Individuals still fill out a W-4, employers still use it to calculate how much of an employee's paycheck should be taxed, and tax filing status is still key. But the IRS revamped and simplified the W-4 form and how taxpayers should calculate their withholding. Now, withholding amounts relate to whether an individual has multiple jobs or a spouse who works, what credits they can claim, and any other adjustments.
For example, withholding is affected if a taxpayer can claim the Child Tax Credit for a qualifying child (or a dependent who is not a qualifying child); if they itemize personal deductions instead of claiming the standard deduction; if they have additional income from dividends, interest, or retirement income; and if they or their spouse has more than one job.
Fortunately, youcan use theIRS Withholding Calculator to see whether you're having the right amount withheld from your paycheck.
Exemption From Withholding
An individual can be exempt from a withholding, but it’s not easy to receive that status. You can claim the withholding exemption only if you had a right to a refund of all federal income tax withheld in the prior year because you didn’t have any tax liability and you expect the same for the current year. You simply write “Exempt” on Form W-4.
This must be done annually; the exemption doesn’t automatically carry over.
When to Recalculate Withholding
A new Form W-4must be filed with the taxpayer’s employer whenever their personal or financial situation changes(e.g., they get married, have a baby, or their spouse enters or leaves the workplace). The new withholding goes into effect no later than the first payroll period ending 30 days after giving the revised form to the employer. The employer may implement it sooner but isn’t required to do so.
A new Form W-4should be filed whenever personal or financial situations change and must go into effect within the first payroll period ending 30 days after the revised form is sent to the employer.
It’s also possible to request that a specific dollar amount be withheld in addition to other tax withholdings. This may be helpful for taxpayers receiving a year-end bonus or for those who simply want to boost withholding near the end of the year (perhaps to cover taxes on investment income, such as capital gain distributions made at the end of the year). Individuals can also request that an additional amount be withheld with Form W-4.
What If Too Little Is Withheld?
The short answer: You are likely to owe money at tax time. And if you have significantly underpaid your taxes during the year, you may have to pay a penalty when you file your annual tax return. If you do not have enough withheld from your paycheck, you can request that your employer withhold an additional dollar sum.
If, on the other hand, you have more income withheld than you should, you will receive a refund after you file your annual income tax return. Receiving a refund isn’t necessarily a good thing—it represents money you could have used throughout the year to pay your bills or invest in the future.
How Much Should I Have Withheld From My Paycheck?
Many people think it’s better to have less money withheld from their paychecks to pay taxes. Alternatively, others prefer to play it safe and overpay, mindful that they will get a refund later on down the line. Both of these approaches aren’t smart. The best option is to fill out Form W-4 as accurately as possible. Doing that will ensure that you don’t get hit with a nasty tax bill out of the blue or essentially give the IRS an interest-free loan.
How Is Withholding Determined?
The withholding amount generally depends on a taxpayer's filing status, number of jobs, other income, and whether they have dependents.
How Do Employers Calculate How Much to Withhold From Employee Pay?
After an employee fills out Form W-4, it is up to the employer to calculate how much to withhold from each paycheck for federal income taxes. Payroll software should have a built-in calculator to work all this out. Alternatively, employers can consult IRS Publication 15-T: Federal Income Tax Withholding Methods.
The Bottom Line
Ensuring the right amount of money is withheld from each paycheck to pay federal income taxes is important. Employees who don't fill out Form W-4 carefully can get hit with a nasty tax bill out of the blue or essentially end up lending the IRS money free of charge.
