Overwithholding

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 overwithheld amount is refunded to the taxpayer after they file a tax return.

Key Takeaways

  • Overwithholding 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. If the tax credit puts the taxpayer's liability below zero, the taxpayer will receive a cash payment from the Internal Revenue Service (IRS).

There are a couple of reasons why excess Social Security might have been overwithheld, according to the IRS. One reason is an employer's error, which occurs when the employer miscalculates and withholds too much Social Security tax from an employee's wages.

The other scenario occurs when an employee has two or more employers in the same taxable year. This typically happens when an employee switches jobs during the year. The new employer may not know how much was withheld by the previous employer. This leads to the new employer mistakenly deducting too much Social Security tax, exceeding the maximum amount due for the year.

Criticism of Overwithholding

Some taxpayers look forward to getting a large tax refund check from the IRS each year. 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 loaning the government your own money for most of the year without paying you any interest in return.

Thus, overpaying your taxes carries with it an opportunity cost. A taxpayer sacrifices other benefits the money could have brought them by allowing overwithholding. The taxpayer could have used the money to pay down debt, save for retirement, or invest at a potentially higher rate of return.

During times of high inflation, it can be particularly critical for taxpayers to ensure excess money is not being withheld from their paychecks. Over time, inflation leads to a decrease in the purchasing power of money. The refund money the taxpayer receives in the future will be worth less, which means it will purchase fewer goods and services.

The opposite of overwithholding is underwithholding, which is when your employer does not withhold enough money from your salary to cover your income taxes. If you find too little is being withheld from your paycheck, you can submit a revised W-4 form to your employer to help you avoid an unexpected tax liability at tax time.

Special Considerations

The IRS encourages taxpayers to check their withholding on a regular basis. This is especially important if the taxpayer has changed jobs or has had a significant life event such as a marriage, birth of a child, adoption, or purchase of a home.

The goal according to the IRS is to move the taxpayer to as close to a zero balance as possible. This means that when they file their tax return no taxes will be owed or a refund due. To help taxpayers check their withholding, the IRS has an online Tax Withholding Estimator, which assists in making sure you have the right amount of tax withheld from your paycheck.

Is There a Penalty for Overwithholding Taxes?

No, the IRS will not charge you a penalty if you pay more tax than was necessary. You will need to file a tax return to request a refund of the money you overpaid. While there is no direct penalty for overpaying your taxes, there is an opportunity cost because you have foregone the opportunity to earn interest on your money or put it to another beneficial use.

How Can You Avoid Overwithholding?

The best way to avoid overwithholding is to check the amount your employer is withholding from your paycheck and determine if it is accurate. You can use the Tax Withholding Estimator from the IRS to find out if the correct amount is being withheld from your paycheck. You can use the results to help you complete a new Form W-4, which you will then submit to your employer.

How Do Employers Calculate Withholding?

To calculate the correct amount to withhold, employers rely on Form W-4 that employees submit to them. To complete Form W-4, the employee must provide identifying information and indicate how they will be filing their taxes (as a single person, married, or head of household).

They must indicate if they have multiple jobs, a working spouse, and any dependents. The taxpayer must also indicate if they want an additional amount withheld from their paycheck. The employer will then use the information the employee has provided to calculate the withholding amount.

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  1. Internal Revenue Service. "Topic No. 608 Excess Social Security and RRTA Tax Withheld." Accessed Nov. 17, 2021.

  2. Internal Revenue Service. "Tax Withholding Estimator." Accessed Nov. 17, 2021.