Taxes Withheld Vs. Actual Tax Burden on Return

By | February 8, 2015

The US Internal Revenue Service mandates that money from your paycheck be withheld throughout the year in preparation for paying your taxes by April 15 of the following year. This withholding is based mostly on two things:

  • The size of your paycheck.
  • The number of allowances you claim on your W-4.


Taxes Withheld Vs. Actual Tax Burden on Return

There are very simple instructions included on the W-4, but the definition of an “allowance” is often confusing. Each W-4 allowance you claim on your W-4 exempts an additional $3,950 from tax withholding. You should always adjust your w4 each year based on your expected withholding. Things like student credits are a year-to-year thing, and if you’re like me you could wind up with more taxes withheld than necessary because you didn’t account for these one-off events and went with “whatever the worksheet says.”


Underwithholding Tax Penalty on Paycheck

Note that there is an underwithholding penalty the IRS imposes for underwithholding too much throughout the year, but claiming additional allowances past what the W-4 instructions indicate for the purposes of reducing your withholding to come closer to your actual tax burden is a legitimate reason. The worksheet is just a rough guide. You can also put in your salary information into the IRS’ Withholding Calculator to see how your withholding lines up with your expected tax burden.


Taxes withheld are not necessarily taxes owed.

Taxes withheld are not necessarily taxes owed. You’ll find out how much tax you owe when you put all your information into the form 1040 + supplemental forms when you file your taxes. If your withholding is larger than your tax burden, you get a “refund.” Unless you like giving the government an interest-free loan throughout the year (“forced savings,” which is attractive to some people), it is in your interest you to adjust your withholdings via the W-4 so your withholding is as close to your expected tax burden as possible. This gives you the maximum amount of money to put to work for you throughout the year.


Paycheck Withholding and Bonuses

One thing that confuses a lot of people is when they get an outsized paycheck, whether due to a bonus or a payroll screwup in a previous pay period. The IRS doesn’t know that it’s a one-time thing, so withholding is usually calculated according to the tables you can find in IRS Publication 15. If this happens to you, you can submit a new W-4 any time you want to in order to adjust your withholding downward temporarily. Some employers withhold tax from bonuses based on a flat rate – check with your employer if this applies to you.

US income tax is highly confusing, but this is a basic explanation of tax withholding as it applies to most people we see here in PF asking about it.