Withholding allowance

A withholding allowance is a number that employees use on their W-4 form to determine how much federal income tax their employer should withhold from their paycheck.

Homebase Team

Min Read

What is a withholding allowance?

A withholding allowance is a number that employees use on their W-4 form to determine how much federal income tax their employer should withhold from their paycheck. The more allowances an employee claims, the less tax is withheld; the fewer allowances claimed, the more tax is withheld.

For small businesses, ensuring employees fill out their W-4 forms correctly is essential for accurate payroll processing and tax compliance. Homebase helps businesses manage payroll seamlessly by tracking tax withholdings and automating tax deductions.

How does a withholding allowance work?

Employers use IRS Form W-4, completed by employees, to determine how much federal income tax to withhold. Before 2020, employees could claim withholding allowances based on personal and dependent exemptions. However, with the IRS’s 2020 W-4 update, the traditional withholding allowance system was replaced with a more straightforward approach that focuses on filing status, dependents, and other income adjustments.

Although withholding allowances are no longer explicitly used on the W-4, the concept still plays a role in tax calculations. Employees now provide information such as:

Filing status (Single, Married Filing Jointly, Head of Household)
Number of dependents
Additional income adjustments (such as second jobs or freelance income)
Additional withholding requests

Why is withholding important for employers?

Employers must ensure accurate tax withholding for their employees to:

Prevent under-withholding – Employees who don’t have enough tax withheld may owe money when they file their tax return.
Avoid over-withholding – Withholding too much reduces employees' take-home pay unnecessarily.
Stay compliant with IRS payroll tax laws – Incorrect tax withholdings can lead to IRS penalties.
Ensure smooth payroll processing – Employees expect accurate deductions on their paychecks.

Using Homebase Payroll, businesses can automate tax withholdings and ensure compliance with IRS requirements.

Try Homebase Payroll today to simplify payroll tax calculations and avoid costly mistakes.

How to calculate tax withholdings correctly

Employers calculate federal income tax withholdings based on:

Employee’s W-4 form details – Filing status, dependents, and additional withholding amounts.
IRS withholding tables – The employer uses the IRS Publication 15-T tax tables to determine the appropriate withholding amount.
Employee’s earnings – Withholding amounts change based on wages and pay frequency.
State tax considerations – Some states require additional income tax withholding.

Can employees change their withholding allowances?

Yes, employees can update their W-4 form at any time to adjust their tax withholding. Common reasons for changing withholding amounts include:

Getting married or divorced
Having a child or gaining a dependent
Starting a second job or freelance work
Major income changes
Wanting a larger tax refund or higher take-home pay

Employers should keep updated W-4 forms on file and apply changes to payroll processing promptly.

Withholding allowances vs. exemptions

Before 2020, withholding allowances were linked to personal and dependent exemptions. However, the Tax Cuts and Jobs Act (TCJA) eliminated personal exemptions, simplifying the W-4 form. Now, instead of claiming allowances, employees:

Indicate their filing status
Enter the number of dependents they can claim
Report extra income adjustments

Employers must follow the updated W-4 system and disregard the previous withholding allowance model.

State withholding allowances

Some states still use a withholding allowance system for state income taxes. Employers should:

Check state tax requirements for payroll withholding.
Ensure employees complete the correct state W-4 form.
Keep records of state-specific withholding elections.

How Homebase Payroll helps businesses manage tax withholdings

Manually calculating tax withholdings can be challenging, but Homebase Payroll simplifies the process by:

Automating federal and state tax withholdings based on employee W-4 forms.
Ensuring compliance with IRS and state tax rules.
Providing payroll reports to track withholdings and deductions.
Allowing employees to update W-4 information easily.

Sign up for Homebase Payroll today to streamline payroll, tax compliance, and employee withholdings.

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