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Income Tax Withholding

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Income Tax Withholding

Federal and state governments don't want to wait for their tax money. They demand that it be collected on a quarterly or even a monthly basis. Chances are good that your employer handles this for you by deducting relevant tax payments from your salary paycheck before paying you each pay period. If you are self employed, however, you will need to file quarterly tax payments or risk penalties at the end of the year.

The amount of tax you owe each year is based on how much you earned. Depending on where your income falls relative to tax bracket categories established by the federal government, the percentage of your taxable income that you owe in taxes changes. Tax bracket categories change annually.  you can find the tables for the current year in Publication 15 from the IRS at:  http://www.irs.gov/pub/irs-pdf/p15.pdf.  This schedule is for federal tax only. Most states and cities also assess taxes, and they also set tax brackets which govern the percentage of your income that you must pay.

Your employer will collect taxes on behalf of relevant governments authorized to tax you (federal, state and city if applicable) based on how much money they estimate you will owe for that year. You have the opportunity to file a form called the W4 which allows you to raise or lower the amount of money your employer will set aside for tax payments each period. At the end of the year you file a tax return in which you figure out definitively how much tax you actually owed that year. If the estimated tax you payed throughout the year was more than the tax you actually owe, you can claim a tax refund. However, if the estimated tax you paid throughout the year was an underestimate of the tax you are responsible for paying, you owe the government money. The estimated tax you pay throughout the year is determined in large part by the number of deductions you claim in your W4. You want to set your W4 deductions so that you slightly overestimate the amount of taxes you will need to pay. The government can punish you with penalties if you underestimate by too much.

It is not in your interest to allow your employer to overestimate how much taxes you will owe by a large amount and then receive a large tax rebate check at the end of the year. The rebate check is not free money from the government; it is money that you earned that year and have not had access to until the end of the year. Allowing that money to be deposited with the government throughout the year is equivalent to giving the government an interest free loan! Not only do you not earn interest on this money; you also are deprived of the opportunity to do things with that money like invest it for interest, or pay bills.