Withholding Allowance: What Is It, and How Does It Work in a Paycheck?

Withholding Allowance

Investopedia / Nez Riaz

What Is a Withholding Allowance?

A withholding allowance refers to an exemption that reduces how much income tax an employer deducts from an employee’s paycheck. In practice, employees in the United States use Internal Revenue Service (IRS) Form W-4: Employee’s Withholding Certificate to calculate and claim their withholding allowance.

Key Takeaways

  • A withholding allowance is an exemption that reduces how much income tax an employer deducts from an employee’s paycheck.
  • Internal Revenue Service (IRS) Form W-4 is used to calculate and claim withholding allowances.
  • The amount of withholding is based on a taxpayer’s filing status—single or married but filing separately, married and filing jointly, or head of household—and the number of withholding allowances they claim.
  • The more allowances you claim, the less income tax will be withheld from a paycheck, and vice versa.
  • Individuals need to file a new Form W-4 whenever their personal or financial situation changes.

Withholding Allowance

How the Withholding Allowance Works

When an individual is hired at a firm, they are required to fill out Form W-4, which includes personal information, such as their name and Social Security number. It also includes the number of allowances to be made.

Once the information is completed, the employer then uses 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 is important—the more tax allowances claimed, the less income tax will be withheld from a paycheck; the fewer allowances claimed, the more tax will be withheld.

The amount of withholding is 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 is important to determine the right number of allowances to claim. This is 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.

Calculating the Withholding Allowance

The IRS provides a rough formula for how many allowances taxpayers should claim to have the correct amount withheld from each paycheck. The withholding allowances relate to whether the individual has multiple jobs or a spouse who works, if they can claim dependents, and any other adjustments.

A withholding allowance could be based, for example, on whether the taxpayer can claim the Child Tax Credit for a qualifying child (or a dependent who is not a qualifying child), whether they itemize personal deductions instead of claiming the standard deduction, whether they or their spouse has more than one job, and what their total income is. Personal exemptions, which have been eliminated by the Tax Cuts and Jobs Act for 2018 through 2025, are no longer taken into account in figuring withholding allowances.

If the employee is single with no children and takes the standard deduction, they can claim one withholding allowance for themselves and a second if they are single with only one job, for a total of two. If, on the other hand, the taxpayer is married filing jointly with no children and claims the standard deduction, they can claim one for themselves, one for their spouse, and a third if they have only one job, if that spouse doesn’t work, or if their second job or the spouse’s job brings in $1,500 or less.

With children or other dependents, it gets more complicated, and the number of allowances claimable is income-based. Fortunately, employees can check their withholding choice using the IRS Withholding Calculator. This enables them to see whether they’ve claimed the right number of withholding allowances.

The IRS Withholding Calculator can help employees determine how many withholding allowances they can claim.

Exemption from the Withholding Allowance

An individual can be exempt from a withholding allowance, 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 Allowances

A new Form W-4 must 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 allowances go 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-4 should 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, regardless of withholding allowances. 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 You Claim Too Many Allowances?

If you claim more allowances than you are entitled to, you are likely to owe money at tax time. If claiming too many allowances results in you significantly underpaying your taxes during the course of the year, you may have to pay a penalty when you file your annual tax return. If, after claiming zero allowances, you find that 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 been using throughout the year to pay your bills or invest for the future.

Is it better to claim 1 or 0 allowances?

The higher the number of allowances, the less tax taken out of your pay each pay period. This means that opting for one rather than zero allowances results in less of your paycheck being sent to the Internal Revenue Service (IRS). Choosing what is suitable depends on your personal circumstances. To avoid underpaying or overpaying, it would be wise to seek guidance and use the IRS Withholding Calculator.

How much withholding allowance should I claim?

Lots of people think it’s better to opt for more allowances so that less money is withheld from their paychecks to pay taxes. Alternatively, there are others who 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 determine when filing Form W-4 how many allowances you qualify for. 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 do you determine withholding allowances?

The number of allowances that a taxpayer can claim generally depends on their filing status, number of jobs, and whether they have dependents.

How do employers calculate how much to withhold from employee pay?

After an employee decides their number of withholding allowances, 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 make a mistake with the number of withholding allowances claimed can get hit with a nasty tax bill out of the blue or essentially end up lending the IRS money free of charge.

Article Sources
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  1. Internal Revenue Service. “About Form W-4, Employee’s Withholding Certificate.”

  2. Internal Revenue Service. “Tax Withholding for Individuals.”

  3. Internal Revenue Service. “Tax Withholding Estimator.”

  4. Internal Revenue Service. “Tax Reform Provisions That Affect Individuals.”

  5. Internal Revenue Service. “Form W-4: Employee’s Withholding Certificate.”

  6. Internal Revenue Service. “Topic No. 753 Form W-4—Employee’s Withholding Certificate.”

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