What Is Overwithholding?
Overwithholding is a generic term referring 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 sent back as a refund to the taxpayer after he or she files a return.
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.
Overwithholding of Social Security benefits is refunded back to the taxpayer in the form of a refundable tax credit.
There are a couple reasons Social Security might be overwithheld, 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."
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."
Even the Internal Revenue Service itself has suggested to taxpayers that it's worth doing their homework to try to avoid overwithholding whenever they can.
In a 2017 alert, 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."