Your employer uses the withholding allowances you claim on your W-4 form to adjust your gross pay before calculating how much federal income tax to withhold from your paycheck. The idea is to withhold enough tax each pay period so that you will have already paid all or most of the tax you owe at the end of the year. If you want to add an additional allowance, you will take home a larger paycheck, but just how much depends on your tax bracket and how much you earn.
The more allowances you claim on your W-4, the more money you will take home each pay period. However, how much of a difference an additional allowance makes depends on your tax bracket and your earnings.
Defining a Withholding Allowance
A withholding allowance is a sum of money subtracted from your gross pay to figure your taxable earnings for federal income tax withholding. The size of a withholding allowance depends on the length of your pay period and is derived from an annual basis amount that is equal to the amount of one personal exemption. For example, in 2019 the annual basis is $4,200, while in 2018 the annual basis was $4,150. To figure the size of a withholding allowance, divide the basis by the number of pay periods. If you are paid weekly in 2019, divide $4,200 by 52 for a withholding allowance of $80.77.
Evaluating Taxable Earnings
Your employer subtracts allowances from your gross pay to figure your taxable earnings for federal income tax withholding. Each withholding allowance you claim reduces your taxable earnings and therefore the amount of tax withheld. You can have additional amounts subtracted from gross pay when calculating taxable earnings.
These amounts might include contributions to a tax-deferred retirement plan, for example. Taxable earnings are used only to figure federal income tax withholding. Social Security and Medicare taxes are computed using your gross pay, so allowances don’t affect them.
Calculating Tax Withheld
The difference in the amount of federal income tax withheld when you claim an additional allowance depends on which tax bracket you are in. Your tax bracket is the highest percentage tax rate applied to your taxable earnings. Suppose your filing status is single, you are paid weekly and your taxable earnings one week come to $1,500. Keep in mind, however, that your filing status will have a direct impact on the amount of tax you owe, even if doesn't directly impact the specific tax bracket you find yourself in. As a general rule, pay close attention to this bracket information in order to ensure that you do not base your tax calculations on faulty figures form the beginning.
In 2019 this put you in the 22 percent tax bracket, which encompasses annual taxable income of between $39,476 and $84,200. One withholding allowance for 2019 is equal to $80.77. If you add a withholding allowance, this decreases taxable earnings by $80.77. The difference made by that withholding allowance was 22 percent of $80.77, or $17.77.
Exploring Overlapping Brackets
Occasionally a withholding allowance overlaps two tax brackets. Suppose your taxable earnings were $1,700 in the above example, and you change your W-4 form to add one allowance because you have a new baby. Your taxable earnings decrease by the amount of one allowance to $1,619.23. This example overlaps the 22 percent bracket and the 24 percent bracket as this example raises your taxable income for the year to $88,400.