Withholding tax (in USA)

Withholding tax is the income tax an employer deducts from pay (or a payer deducts from certain payments) and remits to tax authorities on the recipient's behalf. It spreads a taxpayer's liability across the year, reduces end-of-year balances due, and creates a compliance obligation for the payer.

Withholding applies to employee wages, and in some cases to payments to nonresidents, contractors, dividends, and royalties. Incorrect withholding can lead to employee underpayments, employer penalties, and multi-state or international compliance issues.

What is withholding tax?

Withholding tax is the mechanism by which tax authorities collect income tax at the source of payment. Employers deduct federal, state, and local income tax from employees' wages and remit those amounts to the government. Payers may also withhold on payments to nonresidents, contractors, dividends, or royalties depending on the type of payment and jurisdiction.

Withholding matters because it ensures tax is collected throughout the year rather than in a single lump sum at filing time. For employers, it is a core payroll compliance function — getting it wrong can result in penalties, interest, and liability for unpaid amounts. Deel Payroll automates federal and state withholding calculations, supports multi-state rules for remote workers, and helps apply treaty or nonresident rules where applicable.

How withholding is calculated

Federal income tax withholding: The employer uses the employee's Form W-4 information — filing status, number of dependents, additional withholding requests, and any claimed credits — along with IRS tax tables or the percentage method to calculate the amount to withhold from each paycheck.

State and local withholding: Rules vary by jurisdiction. Most states with an income tax require employers to withhold based on the employee's work location or residence. Some states have their own withholding forms in addition to the federal W-4. Cities like New York City and Philadelphia also impose local withholding requirements.

Supplemental wages: Bonuses, commissions, and other supplemental payments may be withheld at a flat federal rate or using the aggregate method. State supplemental rates vary — see Deel's guide on supplemental tax rates by state.

FICA is separate: Social Security (6.2%) and Medicare (1.45%) taxes are withheld separately from income tax withholding. They have their own rules, caps, and reporting requirements. See Deel's glossary entries on employer payroll taxes and Form 941.

What is a W-4 form and why does it matter?

The W-4 (Employee's Withholding Certificate) tells the employer how much federal income tax to withhold from the employee's paycheck. It captures filing status, dependents, additional income, deductions, and any extra withholding the employee requests.

The W-4 was redesigned in 2020 to align with changes from the Tax Cuts and Jobs Act (TCJA). The new form removed allowances and uses a simpler structure based on filing status and dollar adjustments. Employees should update their W-4 after major life events — marriage, divorce, birth of a child, or a significant income change — to keep withholding accurate.

How to adjust withholding

1. Use the IRS Withholding Estimator. The IRS provides a free online tool to help employees estimate their withholding based on current income, filing status, and deductions.
2. Complete a new W-4. Based on the estimator results, fill out an updated Form W-4 with the correct filing status and any adjustments.
3. Submit to your employer. Give the updated W-4 to your employer's HR or payroll department. The new withholding should take effect within one to two pay periods.
4. Review periodically. Check withholding at least once a year or after any major life change to avoid surprises at tax time.

Withholding for remote and multi-state workers

Remote work creates withholding complexity. Employers must determine which state and local taxes apply based on where the employee physically works, where the employer is located, and any reciprocity agreements between states.

• Work-state rules: Most states require withholding based on where the employee performs work. If an employee moves to a new state, the employer may need to register and withhold in that state.
• Reciprocity agreements: Some neighboring states have agreements that allow employees to pay tax only in their state of residence. Check state-specific rules before adjusting withholding.
• Multi-state employees: Workers who split time between states may owe tax in multiple jurisdictions. The employer must track days worked in each location and withhold accordingly.

Deel Payroll handles multi-state withholding automatically, calculating the correct amounts based on employee location and applicable state rules.

Employer responsibilities and deposit schedules

• Calculate and withhold. Employers must compute the correct federal, state, and local withholding for every paycheck based on employee W-4 information and current tax tables.
• Deposit on schedule. Withheld taxes must be deposited with the IRS on a set schedule — monthly, semi-weekly, or quarterly — depending on the employer's total tax liability. Late deposits incur penalties.
• File periodic returns. Employers file Form 941 quarterly to report wages, tips, and withheld taxes. Annual filers use Form 944. Form 940 covers federal unemployment tax.
• Issue year-end forms. Employers must provide Form W-2 to employees by January 31, showing total wages and all taxes withheld during the year.
• Keep records. Retain payroll records, W-4 forms, and deposit confirmations for at least four years as required by the IRS.

Nonresident withholding

Payments to foreign persons — such as contractor fees, royalties, dividends, or service payments — may be subject to U.S. withholding tax at a default rate of 30%, unless reduced by a tax treaty between the U.S. and the recipient's country.

• Reporting: Payers must report nonresident withholding on Form 1042 and issue Form 1042-S to recipients.
• Treaty benefits: If a tax treaty applies, the recipient must provide Form W-8BEN (individuals) or W-8BEN-E (entities) to claim a reduced withholding rate.
• Backup withholding: If a U.S. payee fails to provide a valid TIN, the payer may be required to withhold at 24% on certain payments.

Key facts

• Employer obligation: Employers are legally responsible for calculating, withholding, and remitting income tax on employee wages.
• Determined by W-4: Federal withholding is based on wages, filing status, and the employee's W-4 information. State and local rules vary.
• FICA is separate: Social Security and Medicare taxes are withheld separately from income tax and have their own rules and caps.
• Nonresident withholding: Payments to foreign persons often use different rates (default 30%) and require Form 1042/1042-S reporting.
• Deposit schedule: Employers must deposit withheld taxes monthly, semi-weekly, or quarterly depending on total liability. Late deposits trigger penalties.

Example

A software engineer living in Colorado works remotely for a U.S. company. The employer withholds federal income tax based on the employee's W-4 and remits Colorado state income tax because the employee resides and works there. If the employee also spends time working from the company's California office, the employer may need to withhold California taxes for those days as well. Deel Payroll calculates both withholdings automatically and produces compliant payslips and deposits.

FAQ

How does tax withholding work for employees? Employers withhold federal and applicable state or local income tax from each paycheck based on gross pay and the employee's W-4 entries, then remit those amounts to tax authorities on a set deposit schedule.

What is a W-4 form and why does it matter? The W-4 tells an employer the employee's filing status and withholding adjustments so the employer can calculate the correct federal income tax withholding for each paycheck.

How can an employee adjust their withholding? Submit a new W-4 to your employer. Use the IRS Withholding Estimator to determine the right settings based on your current income and filing status.

What is withholding tax for nonresidents? Payments to foreign persons may be subject to a default 30% withholding rate unless reduced by a tax treaty. Payers report these amounts on Form 1042-S.

What happens if an employer withholds incorrectly? The employer risks penalties, interest, and liability for unpaid tax. Employees may face an underpayment balance at filing time. Regular payroll audits and updated W-4s reduce this risk.