Withholding Tax Definition

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on January 11, 2021

Define Withholding Tax In Simple Terms

A Withholding tax is an amount of money that an employer withholds from an employee’s salary and pays directly to the government.
This amount is then considered a credit against the employee’s income taxes for that year.
The majority of workers in the US who earn an income from a trade or business will have withholding tax levied upon them.

The Purpose of Withholding Tax In Finance

The purpose of a withholding tax is to allow the US government to tax residents at the source, i.e. their employer, rather than trying to collect taxes after they have been earned.

The primary type of withholding tax is US resident withholding tax, which is collected from every employer in the United States.

The only income exempt from withholding tax is income earned by independent contractors and investors, although those groups are not exempt from income tax.

Withholding Tax Example

Withholding tax may also be levied upon interest and dividend income from securities owned by a nonresident alien, as well as income earned by nonresidents of a country.

This is to ensure that proper taxes are levied on sources of income earned within the US.

Withholding Tax Definition FAQs

A Withholding tax is an amount of money that an employer withholds from an employee’s salary and pays directly to the government.
The amount put aside from a withholding tax is considered a credit against the employee’s income taxes for that year.
The purpose of a withholding tax is to allow the US government to tax residents at the source, i.e. their employer, rather than trying to collect taxes after they have been earned.
The United States governments use a withholding tax to ensure that proper taxes are levied on sources of income earned within the US.