What it means
When you work for an employer in the US, tax on your wages is not paid at the end of the year in one lump. The employer holds back an estimated amount from each paycheck and sends it to the tax authority on your behalf.
This is called withholding. Under the older version of the federal form, an employee entered a number of allowances.
Each one lowered the taxable wage used in the withholding tables by a fixed amount, so a worker with dependants or other deductions could ask for less to be held back. The aim was to make the tax withheld during the year match the final tax bill as closely as possible.
Claiming too many allowances meant too little tax was withheld, and the employee could face a bill and possible penalties, while claiming too few meant a refund after the year ended, which was effectively an interest-free loan to the government. The federal form has since been redesigned and no longer uses allowances.
It asks for filing status and for amounts that reflect extra income, deductions and credits, but older payroll records and some state forms still use the term, so finance and payroll teams will meet it. For employers, the key point is accuracy and timing.
They must apply the form that each employee provides, update withholding when a new form is received, and deposit the amounts withheld by the due dates. Employees should review their withholding after life changes such as marriage, a new child or a second job.
A quick check against the tax authority's estimator can avoid a surprise at filing time.
In practice
Real-world examples.
Example
A newly hired designer fills in the withholding form and claims two allowances because she has a dependant. Her payroll system uses the figure to reduce the wages on which tax is calculated. Each paycheck has slightly less tax withheld as a result.
Example
A payroll clerk at a small manufacturer finds an old employee file that lists four allowances. She checks whether the employee has since submitted the newer form and applies the information that is current. She keeps the old form on file for the retention period.
Example
A worker with two jobs claims the same allowances at both employers. Tax withheld on each job is too low, and at filing time she owes several hundred dollars. A review of her withholding fixes the problem for the next year.
Formula
Calculation
Wages for withholding = Gross pay per period - (Number of allowances x Value of one allowance / Pay periods per year)
Tax withheld = Wages for withholding x Withholding rate
Assume, for illustration, that each allowance reduces annual wages by $2,600 and that the employee is paid 26 times a year. Each allowance is therefore worth 2,600 / 26 = $100 per pay period. An employee earning $2,000 per pay period claims 3 allowances, so wages for withholding = 2,000 - (3 x 100) = 2,000 - 300 = $1,700. At an assumed flat withholding rate of 15%, tax withheld = 1,700 x 15% = $255. With no allowances it would be 2,000 x 15% = $300, so the allowances raise take-home pay by 300 - 255 = $45 per pay period.Case study
Seen in the real world.
Dunmore Print Works is an illustrative, fictional company with 40 employees. During an internal review, the payroll manager found that 12 employees had not updated their withholding since the form changed, and some were still on very high allowance counts.
For one employee, the old record gave 6 allowances at $100 each per pay period, which reduced wages for withholding by 6 x 100 = $600 on gross pay of $2,400. That left $1,800 as the base for tax, which at an assumed 15% meant 1,800 x 15% = $270 instead of 2,400 x 15% = $360.
In the illustrative sequel, the company asked all employees to submit current forms and explained how to check their withholding. The review reduced the number of employees who owed unexpected tax at year end and cut the number of payroll queries in the new year.
Watch out
Common mistakes.
- Claiming more allowances than justified to increase take-home pay, which can lead to a tax bill and penalties at filing time.
- Never updating withholding after marriage, a new child or a second job.
- Thinking a large refund is a bonus, when it simply means too much was withheld during the year.
Questions
People also ask.
Do withholding allowances still exist on the federal form?
No, the federal form was redesigned and no longer uses them, but some state forms and older records still do.
Who decides how many allowances an employee claims?
The employee decides, using the instructions on the form, and the employer applies what the employee provides.
Can an employer ignore a form?
Employers must generally follow the form submitted unless the tax authority tells them to adjust it, so employees are responsible for the accuracy of their claims.
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