What is Paycheck withholding?

By | February 26, 2014

What is the money withheld from my paycheck used for and what is returned in my tax-refund?

A standard check will have FICA taxes withheld (that’s Social Security/Medicare taxes). Depending on how you filled out your W-2 form (i.e., how many deductions) they will also withhold a certain amount to pay your income taxes. This is completely normal and is required by the IRS. Failure to withhold taxes from a paycheck will be bad for the employer and employee.


What is Paycheck withholding?

When you file your taxes the next year, in theory the amount that was withheld should equal the amount you owe. From a practical standpoint, you will almost always get money back–usually because you can take some sort of deduction on your taxes. If you don’t feel like dealing with that, you can always have zero taxes withheld from your paycheck, so long as you realize you’ll have to make a hefty payment in April.


Several typical withholding items on W-4:

  • The biggest is probably either Social Security (which will normally be 7.5% of your income–sometimes Medicare will be separate) or Federal Income Tax withholding. Social security is either paid out as benefits or invested in US government bonds. Federal taxes are compared with annual federal withholding and the difference is paid to whom it is owed.
  • Additionally, any state income taxes (and possibly local income taxes) will be withheld in a manner similar to federal withholding (the excess will be returned or deficiency will be paid at the end of the year)
  • You may also have money for retirement withheld (usually a 401(k)). This is invested with your 401(k) plan sponsor.
  • Another elective option is frequently health insurance. This money along with your employer’s contribution pay for any health insurance premiums.
  • It’s also possible there will be other things ranging from life insurance, Flex spending/HSA plans, payments on loans from one’s 401(k) plan, charitable gifts, or other less likely options (normally these withholding amounts reduce one’s taxable income).


Changing Withholding Amounts on W-4

You can change income tax withholding amounts by filing form W-4s with whomever does payroll for your company. Be careful though as there are penalties that can apply to underwitholding above certain amounts. Typically retirement, health insurance, and other items are elective at least to some extent, but there may be matching amounts paid by one’s employer that are foregone if they are reduced.