Withholding allowances are claimed by employees on their Form W-4 to determine how much federal income tax should be withheld from their paycheck. The number of allowances an employee claims directly affects their take-home pay:
- More allowances claimed: Less tax withheld, resulting in higher take-home pay but a potentially larger tax bill at the end of the year.
- Fewer allowances claimed: More tax withheld, leading to a smaller paycheck but a potential refund at tax time.
Employees can adjust their withholding allowances throughout the year by submitting a new Form W-4 to their employer, particularly when they experience major life changes such as marriage, divorce, the birth of a child, or a significant change in income.
Using the IRS’s Tax Withholding Estimator can help employees calculate the appropriate number of allowances to claim based on their financial situation and tax liability. Properly managing withholding allowances ensures that the right amount of tax is withheld throughout the year, preventing underpayment penalties or large refunds.