Tax withholding is the amount of money cut from an employee's salary or wages to pay taxes to the government directly. Regardless of the amount of money a person earns, withholding tax ensures employees pay what they are eligible for. This tax system prevents individuals from combating tax evasion. Let’s understand what tax withholding is and how to calculate tax withholding.
Tax withholding is the specific amount of money deducted from the income source of individuals to pay the government as tax. It is like a pay-as-you-earn system. The payment is directly paid to the government.
Salaries, bonuses, pensions, commissions, interests, dividends, royalties, and many other fees are counted in tax withholding.
Tax withholding rate varies from country to country. For instance, the withholding tax rate in the United States is 30% and in the United Kingdom it is 20%.
Suppose your monthly salary is $5,000 and your country's withholding tax rate is 30%. Hence, you must pay $1,500 (5000*.30) as tax withholding to the federal government. You will receive a net amount of $3,500 as a salary.
Again, you win a gamble and earn $10,000.The tax withholding for gambling winnings is 25%. You must pay $2,500 (10000*.25) as tax withholding to the federal government. You will receive a net amount of $7,500 as a net amount.
The following are primary reasons you should pay tax withholding.
Paying tax withholding is a good sign that you are respecting the country's tax system. You are fulfilling the government's tax law.
Tax withholding is automatically cut down in advance. You won’t have to worry about paying a huge amount of tax at the end of the year.
Regular payment of tax withholding helps the federal government to maintain a sustainable cash flow. You are directly contributing to the country’s economy.
Regular payment of tax withholding ensures you don’t face penalties for not paying any taxes. You are not involved in any tax evasion or tax avoidance activities.
Tax withholding is the amount of money cut from your earnings at the source. However, the annual tax is the money you pay annually, considering all your income sources.
For example, your monthly salary is $6000. Your tax withholding is 30%. Hence, you pay $1,800 per month.
Your yearly salary is $72,000 (6000*12). Your annual tax withheld is $21,600 (1800*12). If the tax liability is supposed to be 22%, you are liable to pay $15,840. But you have already spent $21,600. Hence, you will get $5,760 refund.
Understanding tax withholding helps you calculate your yearly tax liability. This keeps you stress-free as you are not involved in tax evasion or tax avoidance activities. This article covered what tax withholding is and how to calculate it.
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