The U.S. tax system is "pay as you go," meaning workers make their payments throughout the year as they earn income. Employers withhold money from paychecks and send withholding amounts to the Internal Revenue Service. The amount withheld depends on the number of allowances or exemptions you claim on a W-4 form. The system has been in use since the early 1940s, when the federal government was raising money for the expenses of World War II.
Payroll Tax Withholding
After the establishment of federal income tax in 1913, the government put in place a system of mandatory tax withholding. Complaints from employers about this system led to its repeal in 1917. During the 1930s, when the Social Security Act was passed, the government funded the new Social Security pension system through payroll tax withholding.
Before the 1940s, taxpayers who owed federal income taxes paid them the following year, in quarterly installments. The financial burdens of World War II forced the government to raise more revenue, more frequently, throughout the year. As the federal budget rose tenfold during the war, from $9 billion in 1940 to $98 billion in 1945, Congress passed a law called the Current Tax Payment Act in 1943 to solve this problem.
Tax withholding has continued uninterrupted since the passage of the Current Tax Payment Act. Employees have some control over the amount of income tax withheld, but payroll taxes are fixed and mandated by federal law. As of 2013, Social Security payroll withholding amounts to 6.2 percent of gross wages, paid by the employee and the employer. The IRS collects payroll taxes on behalf of the Social Security trust fund, which continues to pay for retirement and disability benefits. It collects Medicare tax at the rate of 1.45 percent on the first $200,000 of income.
W-4 and Allowances
When you start a job, your employer will have you fill out a W-4. This form declares the number of allowances you are claiming, from zero to 10. Each represents an exemption based on yourself, a spouse and any dependents. You can claim exemption from withholding if you owed no tax in the previous year and expect to owe none in the current year. You can also claim zero allowances, which allows the employer to withhold the maximum amount for the IRS based on your pay, or request the employer withhold even more. This could help someone with additional self-employment income avoid a big bill at tax time.
- Ablestock.com/AbleStock.com/Getty Images