What is a federal withholding allowance?
Withholding is reserving money from an employee ’s paycheck and using those funds to pay the government for federal income taxes and Federal Insurance Contributions Act (FICA) taxes for Medicare and Social Security. The amount you withhold from an employee paycheck will vary based on their filing status, income level and the number of claims they filled out on their new employee forms. The more dependents an employee claims, the less you’ll typically need to withhold from their pay, while the fewer they claim, the more tax you’ll typically need towithhold.
Prior to 2020, an employee could claim a federal withholding allowance . Now, however, taxes are based on factors like an employee’s claimed dependents, if they have more than one job and if their spouse has a job.
Related: How to Hire Your First Employee
How to know if an employee is exempt from withholding
If an employee is exempt from withholding, you’ll see the word "exempt" on their Form W-4. This line is below Step 4(c), but an employee should have also filled out lines one through five. An employee must submit an accurate Form W-4 to you by a predetermined date in February of each year or, as their employer , you file to withhold the normal amount of taxes.
Because the exempt status doesn’t automatically apply to subsequent years, an employee must submit updated paperworkeach year they’re claiming an exempt status.
In general, an employee is exempt when they don’t have any tax liabilities and therefore, will receive a refund of all their federal tax withholdings from the prior year. These exempt employees also expect that the current year will remain the same. An employee can also file exempt status ifno onecan claim them as a dependent or if they fall within certain income levels.
Related: What Are ER Taxes? A Guide to Employer Taxes
What a claim of exemption from withholding doesn’t exempt
Even when an employee completes an exempt tax form, they’re still responsible for some payments out of their paychecks, including FICA taxes for Medicare and Social Security. An exempt employee typicallyonly needs to contribute up to the current Social Security maximum, with you as the employer covering the rest.
Federal tax exemption does not automatically exempt an employee from local or state taxes. If your state collects local and state taxes, the employee may also need to complete documentation to claim exemption from these taxes. Otherwise, youmay need towithhold these taxes.
How to get help with taxes
Knowing how to prepare your own taxes as a small business owner requires both knowledge and time that you may not have. Depending on how you’ve set up your business, you may have to file both business and personal taxes, further adding to the confusion.
However, it’s important to submit accurate paperwork to the Internal Revenue Service (IRS), so consider hiring an accountant for your business taxes. An accountant helps you file taxes, represents you before the IRS and provides tax advice.
To make your tax preparation and filing process go smoothly, consider following these steps:
- Stay organized. Your tax preparer or accountant requires certain documentation to accurately file your taxes. These include payroll documents, last year’s business tax return, your business’s balance sheet and income statements. Consider developing a filing system so these are easy to gather during tax season.
- Separate business and personal expenses. Since you may have to file two different tax forms, make sure your personal expenses are not entered on your business expenses sheet.
- Have the correct business classification. Your business classification determines how you’ll file taxes, so consider speakingwith an accountant and an attorney to make sure you’veclassified your business appropriately, whether that be as an LLC, corporation or another business type, based on your situation.
