When income tax from the employees’ wages is withheld and directly paid to the government by the employer, the employee must pay the amount withheld during that year, as it is a credit against the income taxes. A withholding certificate is required when people want to claim exemptions from withholding the tax on the U.S source income. Moreover, people who want to inform about their foreign or U.S status to the withholding agents also file Withholding Certificate Forms.
The wage earners have to pay federal tax from their earned income because of the pay-as-you-go system of federal income tax. This system was imposed by the federal government to withhold tax on salary income and wages. An individual without enough tax withheld will have to pay the penalties for underpayment. Now you may ask what a tax-withholding certificate is and how it will have an impact on your tax withholding.
If you need help doing a tax withholding certificate call us at 407-502-2400 or email us at [email protected].
A tax-withholding certificate can help you reduce the tax-withhold that is being made on your gross income. To claim the certificate, the person has to submit a form to the concerned authorities. The claim can be accepted or denied depending on the requirements you are meeting.
The federal government introduced a one-time withholding tax during World War II in order to raise revenue. Presently, it is a permanent technique adapted to collect income tax on federal and state levels. The tax that is withheld from the employee’s gross salary goes to the Internal Revenue Services, and to the agency that collects state revenue.
When a new employee is hired on a salary job, the person has to fill out a federal W-4 form. This way, the employer will get the power to hold a certain amount of money from an employee’s earnings to pay it to the government in order to fulfill federal income tax liability.
The W-4 certificate shows the worksheet in the form of an abbreviate tax return and withholding allowances that the employee has claimed. The amount of the withholding allowance that the employee will claim depends on the deductions, exemptions, income, credits, deductions, and the number of withholding allowances. The greater the allowances claimed, the lesser will be the amount of tax withheld on each pay. The objective is to make sure the withheld tax and yearly tax liability are the same.
1. Types of Tax Withholding
Before we go into detail on what are a tax-withholding certificate and its types and categories, let us talk about types of tax withholding. There are three main types of withholding tax that is imposed in the United States at different levels. These include:
- Backup withholding on interest and dividends.
The withheld tax amount depends on the payment amount that is subjected to tax. In some states, the withholding of the tax on wages consists of medicare, income tax, and social security. You will be subjected to income tax withholding only if you earn above a certain amount of wage income. To determine wage withholding, the employee declaration on W-4 federal and state forms and information regarding paid wages is needed. When payments from one employer cross the minimum wage base in a year, then in that case, social security tax withholding is terminated. Any amount of employee’s income that employer and anyone else withheld should be forwarded to the appropriate government on time. The payees and government get a report on the withheld and tax amount on yearly basis.
The taxpayers should review their financial situation in a timely manner and make changes in the W-4 forms accordingly, as recommended by IRS. To make sure that the tax is paid on interest income and dividend, backup withholding is necessary. If the interest income payer or dividend such as banks is unaware regarding the social security number of the taxpayer, the bank will have the power to withhold 31% of the payment as a backup, until the number is not provided. Below are the levels that you should understand before comprehending what a tax-withholding certificate is.
i. Foreign Persons Withholding Payments
A federal income should be withheld on the payments that are made by individuals and companies to foreign persons. These foreign persons can be foreign corporations, nonresident aliens, and foreign partnerships. The withholding payments are the interest, rents, annuities, compensation for services, dividends, royalties, and other payments. Up to 30% of tax is withheld on the gross payment. You can reduce the withholding rate of the tax under a tax treaty. There will be no further payment or tax return needed by the foreign person once the tax is withheld, as it is considered as a final resolve and tax payment.
Moreover, on behalf of foreign partners, the partnerships are supposed to make tax payments in the form of withholding. Whether the income is given to the partner or not, these payments should be made. These are done on a quarterly basis, or at the end of the year for undistributed income such as business income. The partnership payments that are made on business income are treated as estimated tax payments. However, the U.S tax return, which is to report the business income, has to be filed by the foreign person. There should be a 10% withholding of the sales price from foreign sellers’ payments by purchasers of the United States real estate. You can reduce this amount to the expected due to the federal income tax by filling the application on Form 8288-B to the internal revenue service beforehand.
Since the payments are being handled as estimated tax payments, the foreign person should report any gain or loss by filing a U.S tax return.
ii. Withholding Tax on Wages
In some local governments, state, and federal governments in the United States, the employer withholds the tax on the income of the employees. The taxes that are withheld comprises; social security, federal income tax, state income tax, and Medicare. Taxes for other services are also withheld in different states.
The income tax is decided by the number of wages and the declared withholding exceptions amount. The employer decides the figure. At the federal, local, and state levels, the withholding tables and tax rates are applied separately. The withheld amount is decided by the time span covered by the paycheck and wages paid on any paycheck. Since the withholding amounts of federal and some state keep regulating, the greater the wage greater will be the withholding percentages.
For employees, the withheld income taxes are the payment on account that is due for the year. This amount is decided when the annual income tax return is filed at the year’s end. It is the responsibility of an employee to offer the new employee a federal form W-4, which is an employee’s withholding allowance certificate, as stated under internal revenue code section 3402(f)(2) and similar U.S treasury regulations.
The forms used in all the states are almost the same. The employer can get to know the social security number of the employees. The form states the withholding allowances the employee can get. These allowances are based on losses, personal exemptions, losses, and the amount for itemized deductions. The declaration on the Form W-4 by the employee is reliable, and employers can base the tax amount on that information unless they believe it to be false.
If an employee is to pay wages that are above a fixed amount on a yearly basis, that individual will not have to pay off social security tax. The utmost wage in 2015 was $118,500 in which the Medicare tax of 1.45% is withheld from gross income without any higher limit. Similar Medicare taxes should be paid by the employer and the social security taxes is 6.2% rate. There are extra taxes that some of the states impose that are withheld from the gross salary. For different withholding taxes, the definition of wages is different. Therefore, social security wages are different from federal income tax wages, which are also different from state wages.
iii. Withholding Backup
In some situations, payers of dividends, interest, and other items have to withhold federal income tax of 28% on some payments. This is applicable for the recipient of the U.S, or; if the IRS has informed the payers that they should withhold and if the person was unable to provide the payer with tax identification on form W-9.
4. What is a Tax Withholding Certificate?
Tax withholding certificate is also known as retention tax. In this tax, the employer deducts or withholds a certain amount of tax from the income of the payer. The employer gives this tax to the government. Although at most places, this tax is applicable to the employment income, many places also withhold tax on dividends and interest payments. The recipient of the income will also have to pay extra withholding tax if they are residing in a different state. These include; rents, real estate sales, royalties, etc. To fight tax evasion and impose extra withholding tax requirement, the government withhold the tax amount directly from the income.
The tax-withholding certificate helps the individual to claim an exemption on the extra taxes if they fit the requirements. This way, a lesser amount of tax will be withheld. To avail of this, you need to apply for a tax-withholding certificate form.
5. Types of Tax Withholding Certificate Forms
Under IRC sections 1441 – 1464, here are the withholding certificate forms. People who would like to inform their withholding agents of their foreign or U.S states or individuals who wish to claim an exemption on U.S source income from withholding tax have to file withholding certificate forms. These forms are
- Form 8233: Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual
- Form W – 8IMY: Certificate of Foreign Intermediary, Foreign Partnership, Or Certain U.S. Branches for U.S. Tax Withholding
- Form W – 8ECI: Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States
- Form W – 9: Request for Taxpayer Identification Number (TIN) and Certification
- Form W – 8BEN: Certificate of Foreign Status of Beneficial Owner for U.S. Tax Withholding
- Form W – 8EXP: Certificate of Foreign Government or Other Foreign Organization for U.S. Tax Withholding
6. Types of Payments that Attracts Withholding Tax
If you are working in a non-resident company, here are the different types of payments that will attract withholding taxes:
- Management fee payments.
- Real Estate Investment Trust Distribution.
- Payments for purchasing real property from a non-resident property trader.
- Payments for the right to use of the used of movable property or Royalty.
- Payments or Rent for using any movable property.
- All the fees related to loan or debt such as commission and interest.
- Products that are structured, other than those that were exempted from taxes under section 13 of the Income Tax Act.
- Payments made for the right to use or the use of industrial, scientific, commercial, or technical data and knowledge. Payments made for utilizing services that are related to the usage of implementation of those facts and knowledge.
These payments can also be found in Section 12(6) and Section 12(7) of the Income Tax Act.
7. Withholding Certificates Similar to the U.S Real Property Interest
You can get the adjustment on the amount that should be withheld from the disposition of a U.S real property interest by applying for a withholding certificate that the IRS issues. The individuals who can request withholding certificates include the transferee’s agent, the transferee, and the transferor. Once you have submitted the receipt of a complete application with taxpayer-identification numbers (TIN’s) of all the parties to the transaction, the IRS will take action in 90 days. The transferee should be notified by the transferor in writing on the day or the day before making the application for the withholding certificate.
8. Reasons to Issue a Withholding Certificate
Here are the reasons when a withholding certificate can be issued:
If the IRS approves that, a withholding certificate is appropriate because the withheld amount will be greater than the transferor’s maximum liability or withholding of the lesser amount would not jeopardize the tax collection. Moreover, the transferor comprehends the U.S tax exemption of all gain. Additionally, the transferor or transferee can enter an agreement for the tax payment offering security for the tax liability.
9. Categories of Applications for Withholding Certificates
There are six basic categories in which the withholding certificate is divided. You will get specific information through the division in the category regarding the process of the application. The categories are:
- Applications on the basis of blanket withholding certificates.
- Applications for special installment sale rules.
- Basing applications on the assertion that the transfer is exempt from tax or is permitted to nonrecognition treatment.
- Application found on tax payment and conforming security agreement.
- Application-based only on the transferor’s maximum tax liability calculation.
- Application on several other bases.
You need to submit all the required information with verification to the IRS during a specific time duration. If the person is unable to provide the information, it will lead to the rejection of the application. However, if the IRS has granted you the extension of the target date only then you can make a late submission.
People who are not able to pay off the federal taxes on time will be liable to a 100% penalty on the amount that has not been paid. Anyone who is responsible for the funds that help in payment of withheld tax will be assessed. Late payment of the withheld federal taxes will lead to penalties up to 10%, including the interest amount on the balance that was paid behind schedule. On the other hand, the penalties made on the state vary. You will be subjected to the penalties of a maximum $50 on every form that you did not fill and failure to file the tax withholding form. If you are not making the payment of withheld taxes intentionally, you will be liable to criminal penalties.
Therefore, apply for the certificate if you fit the requirements. You can also take the help of a professional to guide you with the filing of the tax-withholding certificate form.
If you need help doing a tax withholding certificate call us at 407-502-2400 or email us at [email protected].