Taxes have been around since time began, but the current income tax system was largely enacted in 1943 through the Current Tax Payment Act. This system made it legal for the government to collect the resources necessary to fund national programs, such as the welfare system, through employer withholding of employee income taxes. When people talk about federal withholding, they are referring to the federal payroll taxes that employers are required to withhold from employees’ wages.
TL;DR (Too Long; Didn't Read)
Federal tax withholding refers to the federal payroll taxes employers are legally required to withhold from their employees' wages and then report and pay to the federal government.
Tax Withholding Process
The Internal Revenue Service is the federal agency responsible for administrating federal tax laws. Federal income tax is a form of tax that the federal government levies on personal income. Social Security and Medicare – also called FICA – taxes are forms of payroll taxes that the federal government also imposes on income. Employees pay these federal payroll taxes via the withholding process. The IRS instructs employers how to comply with federal withholding laws via its Circular E publication.
Federal income tax withholding is based on the employee’s filing status, allowances, and the Circular E’s withholding tax tables. The IRS requires employers give new employees a W-4 form to complete. The employee states her withholding conditions on the form, such as filing status, allowances, additional tax to be withheld per paycheck, or exempt status. If the employee is exempt, the employer does not withhold federal income tax. If the employee does not submit a W-4, the employer can withhold at single filing status with zero allowances.
Notably, self-employed individuals pay these taxes as well, but are not subject to the actual withholding process due to the absence of an employer. As a result, they are required to pay self-employment taxes on a quarterly basis.
Calculating IRS Withholding
The IRS gives employees a certain amount for each allowance claimed on the W-4, this is known as an exemption from withholding. For 2019, the amount per allowance for a weekly payroll is $80.80. Therefore, for a biweekly payroll, which is based on two weeks’ pay, the amount per allowance would be $161.50. The employer cannot guess the withholding amount but must use the Circular E, which gives the exact amount of federal income tax to withhold based on the employee’s income, pay period, filing status, and allowances.
The employer withholds Medicare tax at 1.45 percent of all gross earnings and Social Security tax at 6.2 percent of gross earnings, up to $106,800 for the year. The employer also pays this amount. Self-employed individuals pay the full Medicare amount of 2.9 percent and Social Security amount of 12.4 percent because they do not have an employer to pick up the matching portion.
Federal Withholding Considerations
The IRS requires employers to report and pay all federal income tax and FICA tax withholdings, and the employer’s portion of FICA taxes. The employer files W2s with the Social Security Administration to report annual wages and taxes withheld for each employee. Failure to pay these taxes can result in a penalty of up to 100 percent of the taxes owed and could even result in criminal charges if you willfully chose not to report and pay federal withholdings.
- Department of the Treasury Internal Revenue Service: (Circular E), Employer's Tax Guide
- Department of the Treasury Internal Revenue Service: Form W-4 (2010)
- IRS.gov: Understanding Taxes
- Find Law: Penalties for Violating Federal Employment Tax Rules
- IRS: Notice 1036
- Taxpayer Advocate Service, "Vol. 2, TAS Research and Related Studies: A Conceptual Analysis of Pay-As-You-Earn (PAYE) Withholding Systems as a Mechanism for Simplifying and Improving U.S. Tax Administration," Page 11. Accessed April 1, 2020.
- Internal Revenue Service. "Understanding Taxes -- Theme 2: Taxes in U.S. History." Accessed April 1, 2020.
- Internal Revenue Service. "Form W-4," Accessed April 1, 2020.
- Tax Foundation. "State Individual Income Tax Rates and Brackets," Pages 1–10. Accessed April 1, 2020.
- Social Security Administration. "Contribution And Benefit Base," Accessed April 1, 2020.
- U.S. Congress. "H.R. 748 - CARES Act." Accessed April 1, 2020.
Grace Ferguson has been writing professionally since 2009. With 10 years of experience in employee benefits and payroll administration, Ferguson has written extensively on topics relating to employment and finance. A research writer as well, she has been published in The Sage Encyclopedia and Mission Bell Media.