Loading the player...

What is 'Withholding Tax'

Withholding tax is income tax withheld from employees' wages and paid directly to the government by the employer, and the amount withheld is a credit against the income taxes the employee must pay during the year. It also is a tax levied on income (interest and dividends) from securities owned by a nonresident as well as other income paid to nonresidents of a country.

BREAKING DOWN 'Withholding Tax'

There are two different types of withholding taxes employed by the Internal Revenue Service (IRS) to ensure proper tax is withheld in different situations. The first and more commonly discussed is the withholding tax on personal income that must be done by every employer in the United States. The other form of withholding tax is levied against nonresidents of the United States to ensure proper taxes are made on income sources gained within the United States.

U.S. Resident Withholding Taxes

Withholding taxes is a way for the U.S. government to tax at the source of income, rather than trying to collect income tax after it is earned. This system was implemented in 1943 accompanied by a large tax hike. At the time it was thought that it would be difficult to collect taxes without collecting them from the source. Most employees are legislated and subject to withholding taxes when they are hired by filling out the IRS Form W-4. The form estimates the amount of taxes that will be due.

Generally you want about 90% of your estimated income taxes withheld by the government in this manner. It ensures you never fall behind on income taxes, which has some heavy penalties, but also ensures that you are not overtaxed throughout the year as well. Investors and independent contractors are exempt from withholding taxes but not from income tax. If these classes of taxpayers fall behind they can become liable to backup withholding, which is a higher rate of tax withholding set at 28%.

U.S. states may also have state income taxes and 41 states use withholding tax systems as well to ensure efficient tax collecting from residents. States use a combination of the IRS W-4 form or their own worksheets. Nine states do not charge income tax.

Nonresident Withholding Taxes

The same system of taxing income for nonresident aliens of the United States is employed to ensure effective and efficient tax collecting for the U.S. government. All nonresident citizens, who have not passed the green card test or a substantial presence test, must file Form 1040NR if they are engaged in a trade or business in the United States during the year. There are standard IRS deduction and exemption tables to help you figure out when you should be paying U.S. taxes and which deductions are possible to claim.

Withholding tax is necessary for the vast majority of people that earn income from a trade or business in the United States.

RELATED TERMS
  1. IRS Publication 515

    A document published by the Internal Revenue Service that provides ...
  2. Withholding

    The portion of an employee's wages that is not included in his ...
  3. IRS Publication 15 - Employer's ...

    A document published by the Internal Revenue Service detailing ...
  4. IRS Publication 505

    A document published by the Internal Revenue Service that outlines ...
  5. Backup Withholding

    Tax that is levied on investment income, at an established tax ...
  6. W-4 Form

    A form completed by an employee to indicate his or her tax situation ...
Related Articles
  1. Taxes

    Understanding The U.S. Tax Withholding System

    Understanding the origins of our tax withholding system is crucial to getting the most out of it.
  2. Taxes

    What is Withholding Tax?

    Withholding tax is the income tax federal and state governments require employers to withhold from employee paychecks.
  3. Taxes

    Tax Withholding: Good For Government, Bad For Taxpayers

    It's important to understand where that money coming out of your paycheck goes and why - after all, you earned it.
  4. Taxes

    When You Should Change Your Withholding Tax

    When there are major changes in your life, you should adjust your withholding to ensure you aren't paying too much in taxes.
  5. Taxes

    Understanding Income Tax

    Income tax is a levy many governments place on revenue of entities within their jurisdiction.
  6. Taxes

    Are You Paying Too Much in Taxes?

    Overpaying taxes amounts to an interest-free loan to the government. Here are some ways to avoid that scenario.
  7. Taxes

    When You Should Change Your Withholding Tax

    Paying attention to your W-4 form, and making adjustments when necessary, is an important way to make sure your tax withholdings are correct.
  8. Taxes

    Confused About Estimated Tax Deadlines for 2016?

    If you run a business or have investment income, pay attention to this year's estimated tax deadlines. Here are the details, and what's new for 2016.
  9. Taxes

    The Purpose Of The IRS W-4 Form

    Why do you need to fill out a W-4 form and what does the IRS do with it?
  10. Taxes

    Small Business Tax Obligations: Payroll Taxes

    Don't leave it up to your accountant - owners are ultimately responsible for fulfilling tax obligations.
RELATED FAQS
  1. What's the difference between short-term investments and marketable securities?

    Read about withholding taxes, how they work, and why there are both federal and state withholding lines on the typical American's ... Read Answer >>
  2. Where can I find a good withholding tax table on the Internet?

    Learn where to find the most current withholding tax tables and other information about how income tax withholding rates ... Read Answer >>
  3. What is the optimal level of withholding tax to enter on my W-4?

    Learn about the federal governments payroll tax withholding scheme and how it affects your paycheck, including how to determine ... Read Answer >>
Hot Definitions
  1. Graduate Management Admission Test - GMAT

    A standardized test intended to measure a test taker's aptitude in mathematics and the English language. The GMAT is most ...
  2. Magna Cum Laude

    An academic level of distinction used by educational institutions to signify an academic degree which was received "with ...
  3. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  4. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  5. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  6. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
Trading Center