5. Tax Withholding and Estimated Tax
Important Changes
for 2003
Tax law changes for 2003. When you figure how much income tax you
want withheld from your pay and when you figure your estimated tax, consider tax law
changes effective in 2003. See Important Changes for 2003 in the front of this
publication, or get Publication 553, Highlights of 2002 Tax Changes.
Estimated tax safe harbor for higher income taxpayers. For
installment payments for tax years beginning in 2003, the estimated tax safe harbor for
higher income individuals (other than farmers and fishermen) has been modified. If your
adjusted gross income was more than $150,000 ($75,000 if you are married filing a separate
return), you will have to deposit the smaller of 90% of your expected tax for 2003 or 110%
of the tax shown on your 2002 return to avoid an estimated tax penalty.
Important Reminder
Payment of estimated tax by electronic funds withdrawal. You may be
able to pay your estimated tax by authorizing an automatic withdrawal from your checking
or savings account. For more information, see Payment by Electronic Funds Withdrawal in
chapter 2 of Publication 505.
Introduction
This chapter discusses how to pay your tax as you earn or receive income during the
year. In general, the federal income tax is a pay-as- you-go tax. There are two ways to
pay as you go.
- Withholding. If you are an employee, your employer probably withholds
income tax from your pay. Tax may also be withheld from certain other income - including
pensions, bonuses, commissions, and gambling winnings. In each case, the amount withheld
is paid to the Internal Revenue Service (IRS) in your name.
- Estimated tax. If you do not pay your tax through withholding, or do not
pay enough tax that way, you might have to pay estimated tax. People who are in business
for themselves generally will have to pay their tax this way. You may have to pay
estimated tax if you receive income such as dividends, interest, capital gains, rent, and
royalties. Estimated tax is used to pay not only income tax, but self-employment tax and
alternative minimum tax as well.
This chapter explains both of these methods. In addition, it explains:
- Credit for withholding and estimated tax. When you file your 2002 income
tax return, take credit for all the income tax withheld from your salary, wages, pensions,
etc., and for the estimated tax you paid for 2002, and
- Underpayment penalty. If you did not pay enough tax during the year
either through withholding or by making estimated tax payments, you may have to pay a
penalty. The IRS usually can figure this penalty for you. See Underpayment Penalty at
the end of this chapter.
Useful Items
You may want to see:
Publication
- 505 Tax Withholding and Estimated Tax
- 553 Highlights of 2002 Tax Changes
- 919 How Do I Adjust My Tax Withholding?
Form (and Instructions)
- W-4 Employee's Withholding Allowance Certificate
- W-4P Withholding Certificate for Pension or Annuity Payments
- W-4S Request for Federal Income Tax Withholding From Sick Pay
- W-4V Voluntary Withholding Request
- 1040-ES Estimated Tax for Individuals
- 2210 Underpayment of Estimated Tax by Individuals, Estates, and Trusts
Withholding
This chapter discusses withholding on these types of income:
- Salaries and wages,
- Tips,
- Taxable fringe benefits,
- Sick pay,
- Pensions and annuities,
- Gambling winnings,
- Unemployment compensation, and
- Certain federal payments.
This chapter explains in detail the rules for withholding tax from each of these types
of income.
This chapter also covers backup withholding on interest, dividends, and other payments.
Salaries and Wages
Income tax is withheld from the pay of most employees. Your
pay includes your regular pay, bonuses, commissions, and vacation allowances. It also
includes reimbursements and other expense allowances paid under a nonaccountable plan. See
Supplemental Wages, later, for more information about reimbursements and
allowances paid under a nonaccountable plan.
Military retirees. Military retirement pay is treated in the same
manner as regular pay for income tax withholding purposes, even though it is treated as a
pension or annuity for other tax purposes.
Household workers. If you are a household worker, you can ask your
employer to withhold income tax from your pay. Tax is withheld only if you want it
withheld and your employer agrees to withhold it. If you do not have enough income tax
withheld, you may have to make estimated tax payments, as discussed later under Estimated
Tax.
Farmworkers. Income tax is generally withheld from your cash wages
for work on a farm unless your employer both:
- Pays you cash wages of less than $150 during the year, and
- Has expenditures for agricultural labor totaling less than $2,500 during the year.
If you receive either noncash wages or cash wages not subject to withholding, you can
ask your employer to withhold income tax. If your employer does not agree to withhold tax,
or if not enough is withheld, you may have to make estimated tax payments, as discussed
later under Estimated Tax.
Determining Amount
of Tax Withheld
The amount of income tax your employer withholds from your regular pay depends on two
things.
- The amount you earn.
- The information you give your employer on Form
W-4.
Form W-4 includes three types of information that your employer will use to figure your
withholding.
- Whether to withhold at the single rate or at the lower married rate.
- How many withholding allowances you claim. (Each allowance reduces the amount withheld.)
- Whether you want an additional amount withheld.
If your income is low enough that you will not have to pay income tax for the year, you
may be exempt from withholding. This is explained under Exemption From Withholding, later.
Note. You must specify a filing status and a number of
withholding allowances on Form W-4. You cannot specify only a dollar amount of
withholding.
New job. When you start a new job, you must fill out Form W-4 and
give it to your employer. Your employer should have copies of the form. If you need to
change the information, you must fill out a new form.
If you work only part of the year (for example, you start working after the beginning
of the year), too much tax may be withheld. You may be able to avoid overwithholding if
your employer agrees to use the part-year method. See Part-year method in chapter
1 of Publication 505 for more information.
Changing your withholding. Events during the year may change your
marital status or the exemptions, adjustments, deductions, or credits you expect to claim
on your return. When this happens, you may need to give your employer a new Form W-4 to
change your withholding status or number of allowances.
If the event changes your withholding status or the number of allowances you are
claiming, you must give your employer a new Form W-4 within 10 days after
either of the following.
- Your divorce, if you have been claiming married status.
- Any event that decreases the number of withholding allowances you can claim.
Generally, you can submit a new Form W-4 whenever you wish to change the number of your
withholding allowances for any other reason.
Changing your withholding for 2004. If events in 2003 will
decrease the number of your withholding allowances for 2004, you must give
your employer a new Form W-4 by December 1, 2003. If the event occurs in December 2003,
submit a new Form W-4 within 10 days.
Cumulative wage method. If you change the number of your withholding
allowances during the year, too much or too little tax may have been withheld for the
period before you made the change. You may be able to compensate for this if your employer
agrees to use the cumulative wage withholding method for the rest of the year. You must
ask in writing that your employer use this method.
To be eligible, you must have been paid for the same kind of payroll period (weekly,
biweekly, etc.) since the beginning of the year.
Checking your withholding. After you have given your employer a Form
W-4, you can check to see whether the amount of tax withheld from your pay is too little
or too much. See Getting the Right Amount of Tax Withheld, later. If too much or
too little tax is being withheld, you should give your employer a new Form W-4 to change
your withholding.
Note. You cannot give your employer a payment to cover
withholding for past pay periods or a payment for estimated tax.
Completing Form W-4
and Worksheets
Form W-4 has worksheets to help you figure how many withholding allowances you can
claim. The worksheets are for your own records. Do not give them to your employer.
You do not have to use the Form W-4 worksheets if you use a more accurate method of
figuring the number of withholding allowances. See Alternative method of figuring
withholding allowances under Completing Form W-4 and Worksheets in chapter 1
of Publication 505 for more information.
Two jobs. If you have income from two jobs at the same
time, complete only one set of Form W-4 worksheets. Then split your allowances between the
Forms W-4 for each job. You cannot claim the same allowances with more than one employer
at the same time. You can claim all your allowances with one employer and none with the
other, or divide them any other way.
Married individuals. If both you and your spouse are employed and
expect to file a joint return, figure your withholding allowances using your combined
income, adjustments, deductions, exemptions, and credits. Use only one set of worksheets.
You can divide your total allowances any way, but you cannot claim an allowance that your
spouse also claims.
If you and your spouse expect to file separate returns, figure your allowances
separately based on your own individual income, adjustments, deductions, exemptions, and
credits.
Personal allowances worksheet. Use the Personal Allowances
Worksheet on page 1 of Form W-4 to figure your withholding allowances for exemptions
and any special allowances that apply.
Deductions and adjustments worksheet. Fill out this worksheet to
adjust the number of your withholding allowances for deductions, adjustments to income,
and tax credits. The Deductions and Adjustments Worksheet is on page 2 of Form
W-4. Chapter 1 of Publication 505 explains this worksheet.
Two-earner/two-job worksheet. You may need to complete this
worksheet if you have two jobs or a working spouse. You can also add to the amount, if
any, on line 8 of this worksheet, any additional withholding necessary to cover any amount
you expect to owe other than income tax, such as self-employment tax.
Getting the Right Amount
of Tax Withheld
In most situations, the tax withheld from your pay will be close to the tax you figure
on your return if you follow these two rules.
- You accurately complete all the Form W-4 worksheets that apply to you.
- You give your employer a new Form W-4 when changes occur.
But because the worksheets and withholding methods do not account for all possible
situations, you may not be getting the right amount withheld. This is most likely to
happen in the following situations.
- You are married and both you and your spouse work.
- You have more than one job at a time.
- You have nonwage income, such as interest, dividends, alimony, unemployment
compensation, or self-employment income.
- You will owe additional amounts with your return, such as self-employment tax.
- Your withholding is based on obsolete Form W-4 information for a substantial part of the
year.
To make sure you are getting the right amount of tax withheld, get Publication 919. It
will help you compare the total tax to be withheld during the year with the tax you can
expect to figure on your return. It also will help you determine how much additional
withholding, if any, is needed each payday to avoid owing tax when you file your return.
If you do not have enough tax withheld, you may have to make estimated tax payments, as
explained under Estimated Tax, later.
Rules Your Employer
Must Follow
It may be helpful for you to know some of the withholding rules your employer must
follow. These rules can affect how to fill out your Form W-4 and how to handle problems
that may arise.
New Form W-4. When you start a new job, your employer should give
you a Form W-4 to fill out. Your employer will use the information you give on the form to
figure your withholding beginning with your first payday.
If you later fill out a new Form W-4, your employer can put it into effect as soon as
possible. The deadline for putting it into effect is the start of the first payroll period
ending 30 or more days after you turn it in.
No Form W-4. If you do not give your employer a completed Form W-4,
your employer must withhold at the highest rate - as if you were single and claimed no
allowances.
Repaying withheld tax. If you find you are having too much tax
withheld because you did not claim all the withholding allowances you are entitled to, you
should give your employer a new Form W-4. Your employer cannot repay any of the tax
previously withheld.
However, if your employer has withheld more than the correct amount of tax for the Form
W-4 you have in effect, you do not have to fill out a new Form W-4 to have your
withholding lowered to the correct amount. Your employer can repay the amount that was
incorrectly withheld. If you are not repaid, your Form W-2 will reflect the full amount
actually withheld.
Exemption From Withholding
If you claim exemption from withholding, your employer will not
withhold federal income tax from your wages. The exemption applies only to income
tax, not to social security or Medicare tax.
You can claim exemption from withholding for 2003 only if both the
following situations apply.
- For 2002 you had a right to a refund of all federal income tax withheld because
you had no tax liability.
- For 2003 you expect a refund of all federal income tax withheld because you
expect to have no tax liability.
Student. If you are a student, you are not automatically exempt. See
chapter 1 to see whether you must file a return. If you work only part time or only during
the summer, you may qualify for exemption from withholding.
Age 65 or older or blind. If you are 65 or older or blind, use one
of the worksheets in chapter 1 of Publication 505, under Exemption From Withholding, to
help you decide whether you can claim exemption from withholding. Do not use either
worksheet if you will itemize deductions or claim exemptions for dependents or claim tax
credits on your 2003 return. See Itemizing deductions or claiming exemptions or tax
credits in Publication 505.
Claiming exemption from withholding. To claim exemption, you must
give your employer a Form W-4. Print EXEMPT on line 7.
Your employer must send the IRS a copy of your Form W-4 if you claim exemption from
withholding and your pay is expected to usually be more than $200 a week. If it turns out
that you do not qualify for exemption, the IRS will send both you and your employer a
written notice.
If you claim exemption, but later your situation changes so that you will have to pay
income tax after all, you must file a new Form W-4 within 10 days after the change. If you
claim exemption in 2003, but you expect to owe income tax for 2004, you must file a new
Form W-4 by December 1, 2003.
An exemption is good for only one year. You must give your
employer a new Form W-4 by February 15 each year to continue your exemption.
Supplemental Wages
Supplemental wages include bonuses, commissions, overtime pay, and certain sick pay.
The payer can figure withholding on supplemental wages using the same method used for your
regular wages. If these payments are identified separately from your regular wages, your
employer or other payer of supplemental wages can withhold income tax from these wages at
a flat rate of 27%.
Expense allowances. Reimbursements or other expense allowances paid
by your employer under a nonaccountable plan are treated as supplemental wages.
Reimbursements or other expense allowances paid under an accountable plan that are more
than your proven expenses are treated as paid under a nonaccountable plan if you do not
return the excess payments within a reasonable period of time.
For more information about accountable and nonaccountable expense allowance plans, see Reimbursements
in chapter 28.
Penalties
You may have to pay a penalty of $500 if both of the following apply.
- You make statements or claim withholding allowances on your Form W-4 that reduce the
amount of tax withheld.
- You have no reasonable basis for those statements or allowances at the time you prepare
your Form W-4.
There is also a criminal penalty for willfully supplying false or fraudulent
information on your Form W-4 or for willfully failing to supply information that would
increase the amount withheld. The penalty upon conviction can be either a fine of up to
$1,000 or imprisonment for up to one year, or both.
These penalties will apply if you deliberately and knowingly falsify your Form W-4 in
an attempt to reduce or eliminate the proper withholding of taxes. A simple error - an
honest mistake - will not result in one of these penalties. For example, a person who has
tried to figure the number of withholding allowances correctly, but claims seven when the
proper number is six, will not be charged a W-4 penalty.
Tips
The tips you receive while working on your job are considered part of
your pay. You must include your tips on your tax return on the same line as your
regular pay. However, tax is not withheld directly from tip income, as it is from your
regular pay. Nevertheless, your employer will take into account the tips you report when
figuring how much to withhold from your regular pay.
See chapter 7 for information on reporting your tips to your employer. For more
information on the withholding rules for tip income, see Publication 531, Reporting
Tip Income.
How employer figures amount to withhold. The tips you report to your
employer are counted as part of your income for the month you report them. Your employer
can figure your withholding in either of two ways.
- By withholding at the regular rate on the sum of your pay plus your reported tips.
- By withholding at the regular rate on your pay plus an amount equal to 27% of your
reported tips.
Not enough pay to cover taxes. If your regular pay is not enough for
your employer to withhold all the tax (including social security tax, Medicare tax, or
railroad retirement tax) due on your pay plus your tips, you can give your employer money
to cover the shortage.
If you do not give your employer money to cover the shortage, your employer will first
withhold as much social security tax, Medicare tax, or railroad retirement tax as
possible, up to the proper amount, and then withhold income tax up to the full amount of
your pay. If not enough tax is withheld, you may have to make estimated tax payments. When
you file your return, you also may have to pay any social security tax, Medicare tax, or
railroad retirement tax your employer could not withhold.
Allocated tips. Your employer should not withhold income tax, social
security tax, Medicare tax, or railroad retirement tax on any allocated tips. Withholding
is based only on your pay plus your reported tips. Your employer should
refund to you any incorrectly withheld tax. See Allocated Tips in chapter 7 for
more information.
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