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What is 'Withholding Allowance'

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 to calculate and claim their withholding allowance. 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 more allowances claimed, the less income tax will be withheld from a paycheck. The fewer allowances you claim, the more income tax will be withheld from each paycheck.

BREAKING DOWN 'Withholding Allowance'

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 your 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 you have more 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, though, as it represents money you could have been using throughout the year to pay your bills or invest. You are effectively giving the government an interest-free loan when you have too much withheld.

Calculating Your Withholding Allowance

The IRS provides a rough formula for how many allowances taxpayers should claim in order to have the correct amount withheld from each paycheck. You can claim one allowance for yourself, one for your spouse and one for each of your dependents. When your personal or financial situation changes (for example, you get married, take out a mortgage or get a second job), you should recalculate your withholding allowance and submit a new form W-4 to your employer. If you don’t submit IRS form W-4 to your employer showing how many allowances you want to claim, your employer will assume that this number is zero, and you’ll have the maximum amount of income tax withheld from each paycheck. For more, see the IRS Withholding Calculator.

Withholding Allowance Examples

Two people earn the same salary at the same company but can have very different tax burdens. Jack is unmarried, has no children and supports only himself. He can claim just one exemption (himself). Diane is married and has two children, which gives her four exemptions: one for each child, one for herself and one for her spouse. Given that she has more withholding allowances she will have less money withheld from her paycheck. For more, see the Form W-4 informational page.

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