What Is Overwithholding?

Overwithholding is a generic term that refers to an excess amount of tax being deducted from an employee's paycheck or for a retirement plan throughout the course of a year.

Any amount of overwithholding is refunded to the taxpayer after they file a tax return.

Key Takeaways

  • Overwitholding means that the IRS has withheld excess money from your income taxes.
  • Excess withholding often results in a refund to the taxpayer.
  • Some people enjoy getting a big refund check at the end of the year.
  • But you actually lose out that way because you're letting the IRS use your money without paying you interest.

Understanding Overwithholding

Overwithholding is also known as excess withholding. When this is related to income taxes, it commonly occurs when a bonus or above-average lump sum payment skews the numbers. It also could happen simply because you filled out your Form W-4 incorrectly. If you’re getting a sizable refund just about every year, then you’re probably having too much withheld for federal taxes.

Overwithholding of Social Security benefits is returned to the taxpayer in the form of a refundable tax credit.

There are a couple of reasons why excess Social Security might have been over withheld, as Zacks explains: either multiple employers over the course of a year don't pass along information, or a single employer makes a mistake with withholding levels.

"The Internal Revenue Code sets the maximum amount employers may withhold from paychecks for Social Security tax in one fiscal year," according to Zacks. "But a problem sometimes occurs when you change jobs within the same year: Not knowing how much has already been withheld, your new employer may inadvertently deduct too much from your paycheck, throwing your Social Security contributions over the limit."

In another scenario, "the same employer you had all year might deduct more than necessary from your income. For each situation, the Internal Revenue Service offers a solution for you to obtain a refund."

Overwithholding Has No Real Benefit

The argument against income tax overwithholding is perhaps best explained by CNBC: "If the IRS sends you a huge check this spring, it means you've likely overpaid on taxes throughout the year."

The site quotes Tim Steffen, director advanced planning at Robert W. Baird & Co: "A large refund from the IRS may seem like an advantage, but it isn't the best or most effective use of your cash flow," he said. "You're basically giving the IRS an interest-free loan."

Who wouldn't want to get a big tax refund check from the Internal Revenue Service (IRS), right? But think again: When you get a big refund, you’re just getting your own money back; but with no interest. In effect, you're letting the IRS use your own money for most of the year without paying you any interest.

Add up this year’s tax refund and divide it by 12. During the year, stow that amount in an interest-bearing account to keep more of your hard-earned cash. And don't forget to adjust the withholding code on IRS Form W-4 for the next tax year.

Even the IRS Suggests Avoiding Overwithholding

In a 2017 news release, the IRS "encouraged taxpayers to consider checking their tax withholding, keeping in mind several factors that could affect potential refunds or taxes they may owe in 2018. Reviewing the amount of taxes withheld can help taxpayers avoid having too much or too little federal income tax taken from their paychecks. Having the correct amount taken out helps to move taxpayers closer to a zero balance at the end of the year when they file their tax return, which means no taxes owed or refund due."