Employers are required to subtract taxes from an employee's pay and remit them to the U.S. government in a process referred to as "federal income tax withholding." Employees can then claim credit on their tax returns for the amounts that were withheld. Employers are required to withhold federal income tax, Social Security tax, and Medicare tax from employees' earnings.
Federal Income Tax Withholding
The amount of taxes that an employer must withhold and remit to the IRS depends on how much in the way of gross income you've earned in the form of wages for the year. Pre-tax deductions, such as retirement plan contributions, are subtracted first before withholding is calculated on the remaining balance.
Employers use the information included on Form W-4, completed by each of their employees, to calculate the amount of federal income tax to withhold from each of their paychecks.
How To Calculate Withholding on Form W-4
Withholding allowances used to correspond with the number of personal exemptions that taxpayers were entitled to claim on their tax returns for themselves, their spouses, and their dependents, but the Tax Cuts and Jobs Act (TCJA) eliminated personal exemptions from the tax code in 2018.
The IRS rolled out a revised Form W-4 for the 2020 tax year to accommodate this tax code change. The new form is much easier to complete than the previous version. It does much of the work for you—it's largely a matter of simply answering some questions. The form will provide you—or, more accurately, your employer—with the correct amount to be withheld from your pay based on your responses.
You can use the Tax Withholding Estimator on the IRS website if you're still feeling a bit confused when you're tackling Form W-4.
Changing Your Withholding
You're not stuck forever with the withholding calculation you arrived at when you first completed a Form W-4 for your employer, or if you make errors on the revised form. You can change your W-4 at any time during the tax year to adjust for more withholding or less depending on your circumstances.
In fact, the IRS advises that you revise your form if:
- You (or your spouse) picks up a second job or lose secondary sources of income.
- You experience major life changes, such as marriage, divorce, death of a spouse, or the birth or adoption of a child.
- You qualify for fewer—or more—tax deductions, credits, or adjustments to income.
It's also a good idea to review your withholding whenever there have been changes in tax law, which has occurred numerous times since late 2017.
You Might Be Exempt From Withholding
A few individuals are exempt from withholding, so no federal income tax has to be withheld from their pay. This can happen because they owed no income tax in the prior tax year and they don't expect to owe income tax in the current year, either.
You can indicate that you're exempt on Form W-4 if you qualify and, in fact, you must if you don't want tax withheld. Your employer is still obligated to withhold from your pay otherwise. But bear in mind that you could owe a substantial lump-sum tax debt at the end of the year if your calculations are wrong and nothing has been withheld from your pay all year.
This rule applies only to income tax, not to FICA taxes—the Social Security and Medicare withholdings.
Social Security Withholding on Wages
Wages are subject to other forms of withholding in addition to the federal income tax. The Social Security tax is withheld at a flat rate of 6.2% on gross wages after subtracting any pre-tax deductions that are exempt from Social Security taxation.
Not all gross wages are subject to this tax. An annual wage base limit caps earnings that are subject to withholding for Social Security at $147,000 in 2022, up from $142,800 in 2021. Income over this amount isn't subject to Social Security withholding.
The amount withheld is usually equal to the amount of Social Security tax for which an employee is liable because the Social Security tax is assessed as a flat rate with a maximum cap on earnings. There are some exceptions, however, and taxpayers can end up overpaying or underpaying through withholding.
Overpaid Social Security Tax
Employees who work for two or more employers might find that they've overpaid their Social Security taxes because their total wage income from all sources exceeds the annual Social Security wage base. One employer might not know about earnings from another that can push your overall wages over the wage base limit, so they continue withholding even though they no longer have to.
Any overpaid Social Security tax can be refunded if you claim the excess as a tax credit when you file your return.
Underpaid Social Security Tax
Social Security taxes can be underpaid in three ways.
Underreported Tip Income
Some employees receive tips but don't report them to their employers, so no tax is withheld from this money. You should use Form 4137 to calculate the amount of Social Security and Medicare tax due on unreported tips and report this additional amount on your tax return.
Misclassification as an Independent Contractor
Some workers are incorrectly classified by their employers as independent contractors rather than as employees. Their earnings would not have any tax withheld in this case because independent contractors are responsible for remitting their own estimated taxes to the IRS as the year goes on.
Use Form 8919 to calculate the amount of Social Security and Medicare tax on your earnings in this case. Report this additional amount on your annual tax return.
Group Term Life Insurance
Some retirees might receive coverage under a group term life insurance policy from their former employer. This insurance is taxable if the policy value is over $50,000.
A retiree might not have any cash earnings associated with their retirement benefits from which an employer can withhold taxes for this purpose. Your Form W-2 will indicate the uncollected Social Security and Medicare tax using the codes M and N in Box 12 in this case. You can then add these amounts to your return for the year.
Underpaid Medicare Tax
Medicare tax is withheld at the rate of 1.45% of gross wages after subtracting for any pre-tax deductions that are exempt, just as with Social Security. Medicare is assessed at this flat rate and there's no wage base, so the amount withheld is usually equal to the amount for which an employee is liable.
But a 0.9% Medicare surtax has been in place for higher-income earners since 2013, and this can cause under-withholding if you're subject to it. Earnings subject to this tax as of 2021 depend on your filing status. You must pay the surtax on earnings over:
- $125,000 for married taxpayers who file separate returns
- $200,000 for single taxpayers
- $200,000 for heads of household
- $200,000 for qualifying widow(ers)
- $250,000 for married taxpayers who file joint returns
It's possible that some taxpayers might not have this additional amount withheld from their pay, so any additional Medicare tax that's due will be calculated on their tax returns and would become due at that time.
Frequently Asked Questions (FAQs)
What is the federal tax withholding rate?
The federal withholding rate depends on your filing status, taxable income, and exemptions. From their taxable income (after any pre-tax deductions), most taxpayers will have 6.2% withheld for Social Security, 1.45% for Medicare, and federal income taxes depending on any exemptions on the W-4.
Why is there no federal tax taken out of my paycheck?
If you have not had any federal taxes withheld from your paycheck, it could be an error on the part of your employer, or you may have filled out your W-4 incorrectly. Follow up with your employer quickly to avoid racking up an unexpected year-end tax bill.
What is the difference between federal and state taxes?
State taxes are collected by state tax agencies, and percentages vary by state. Some states collect no income tax at all. There is also no state-level taxation for Medicare or Social Security since these are federal programs.