A withholding allowance is a claim that someone can make to reduce the amount of money withheld from his or her paychecks. Employers are required to withhold some funds from each paycheck and submit these funds to tax agencies. At the end of the year, employees sit down to do their income taxes and determine how much they owe. The money withheld from the paychecks is applied to the total tax bill, and in some cases the employee may end up with a refund because too much was withheld, while in others, the employee may have a balance due.
In the United States, employees file withholding allowances on a Form W-4, a form that is usually provided by the employer. People are allowed to claim themselves as a withholding allowance, if they are not being claimed by anyone else, and dependents can be claimed as well. Allowances are also available for the heads of household and people in certain other circumstances.
The more withholding allowances a taxpayer claims, the less the employer will withhold from each paycheck. This results in more money coming into the household every month. However, it can also put employees at risk of having a balance due when they do their taxes. If people do not claim enough holding allowances, on the other hand, too much will be withheld and they will have to wait for a refund at the end of the year.
People who notice that they get big refunds every year may want to consider filing a new Form W-4 with updated withholding allowance information so that they get more money in their monthly paychecks. On the other end of the scale, people who owe money each year and struggle to pay it could opt to update their W-4s with fewer withholding allowances so that they will not be stuck with a big tax bill every April.
The allowances claimed on the Form W-4 do not have to match those claimed on a tax return. Some people use the withholding allowance as a money management strategy. They may not file any allowances so that they can anticipate a big refund when they file their taxes, for example, or they may claim every possible withholding allowance and invest that money over the course of the year. This allows them to earn money while also setting funds aside to pay taxes, although taxpayers should be careful because they can be penalized for underwithholding. An accountant can provide advice about withholding allowances for someone who is not sure about how to proceed.