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:

1. Pays you cash wages of less than $150 during the year, and
2. 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.

1. The amount you earn.
2. 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.

1. Whether to withhold at the single rate or at the lower married rate.
2. How many withholding allowances you claim. (Each allowance reduces the amount withheld.)
3. 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.

1. Your divorce, if you have been claiming married status.
2. 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.

1. You accurately complete all the Form W-4 worksheets that apply to you.
2. 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.

1. For 2002 you had a right to a refund of all federal income tax withheld because you had no tax liability.
2. 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.

1. You make statements or claim withholding allowances on your Form W-4 that reduce the amount of tax withheld.
2. 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.

1. By withholding at the regular rate on the sum of your pay plus your reported tips.
2. 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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