Julian Drago
October 3, 2025
Tax withholding is a core mechanism in the U.S. tax system. In simple terms, a portion of your income is automatically deducted before you receive your pay. That amount is sent directly to the Internal Revenue Service (IRS) as an advance payment toward the taxes you’ll owe at year-end.
While the concept can seem complex, understanding how withholding works is essential if you run a business or work in the United States—it directly affects your tax obligations.
Tax withholding is a way to collect taxes in advance. Rather than waiting for each taxpayer to pay once a year, the IRS requires employers, financial institutions, and certain payers to withhold a portion of income at the time of payment.
This method ensures the government receives revenue consistently throughout the year and helps taxpayers avoid a large one-time burden when filing the annual return.
There are several types of withholding in the U.S., depending on the income or the taxpayer.
This is the most common type. Employers must withhold federal, state, and sometimes local taxes on employees’ pay.
The amount withheld depends on:
This withholding typically includes:
When a U.S. person or entity pays a nonresident (e.g., interest, royalties, or dividends), it generally must withhold 30% of the gross amount.
However, income tax treaties can reduce that rate if the beneficial owner qualifies and provides the proper documentation.
This applies when a payee fails to provide a Taxpayer Identification Number (TIN/SSN) to the payer, or if the IRS notifies the payer of issues with the account. In such cases, the payer must withhold 24% on certain types of payments.
The duty to withhold and remit taxes falls on withholding agents, which may include:
Withholding agents must deposit withheld amounts with the IRS on time (monthly or semiweekly, depending on volume) and file the appropriate forms, such as Form 941 (for employers) or Form 1042-S (for payments to foreign persons).
Withholding acts as a prepayment of your income tax.
When you file your annual return (Form 1040), the IRS compares your total withholding with your actual tax liability:
That’s why it’s important to keep your W-4 current and use the IRS Tax Withholding Estimator to check whether your withholding is on target.
If you have a U.S.-registered company and pay suppliers or partners in other countries, you need to understand withholding tax rules.
The IRS generally requires withholding on certain U.S.-source payments made to nonresidents. The applicable rate may be reduced under an income tax treaty. Proper documentation (e.g., Form W-8BEN or W-8ECI) is essential to apply treaty benefits.
Improper withholding can trigger penalties, interest, and even personal liability for responsible parties.
What if my employer doesn’t withhold correctly?
Your employer may face penalties, but you are still responsible for paying any tax due when you file your return.
Can I change how much is withheld from my paycheck?
Yes. You can update your Form W-4 at any time to adjust withholding and avoid large refunds or unexpected balances due.
How does withholding work for self-employed individuals?
Traditional wage withholding doesn’t apply. Instead, self-employed individuals generally make quarterly estimated tax payments.
Can foreign persons avoid withholding?
Only if they qualify under an income tax treaty and submit the proper forms (such as W-8BEN or W-8ECI) to the payer.
Understanding tax withholding is essential to keep your business compliant and avoid penalties. If you’re forming or managing a company in the U.S., Openbiz can guide you through the administrative and tax steps so you operate legally, safely, and efficiently.
Contact us today to set up your company the right way and handle withholding and other tax obligations with confidence.
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