Withholding Allowance: What It Is and How It Works

Overview

A withholding allowance was an exemption used to reduce the amount an employer withheld from an employee’s paycheck for federal income tax. It was tied to the personal exemption that existed before 2018. The Tax Cuts and Jobs Act (TCJA) of 2017 eliminated personal exemptions for tax years 2018–2025 and removed withholding allowances from the redesigned Form W‑4. Form W‑4 is still the form employees use to tell employers how much federal income tax to withhold.

How withholding allowances worked (pre‑2018)

• Employees completed Form W‑4 when hired, listing personal details and the number of allowances.
• Employers used the number of allowances and filing status (single, married filing jointly, married filing separately, head of household) to determine withholding.
• The more allowances claimed, the less tax withheld; fewer allowances meant more withheld.
• Claiming the correct number helped avoid underpaying tax (and penalties) or overpaying and effectively giving the government an interest‑free loan.

Current system (post‑TCJA)

• Personal exemptions and withholding allowances were removed from Form W‑4.
• Withholding is now based on:
• Filing status
• Whether you (or your spouse) have multiple jobs
• Claims for credits (e.g., Child Tax Credit)
• Whether you itemize deductions or take the standard deduction
• Other income (dividends, interest, retirement income) and adjustments
• The IRS provides a Tax Withholding Estimator to help determine whether your withholding is correct.

Claiming a complete exemption from withholding

You may be exempt from federal income tax withholding for a year if both conditions apply:
1. You received a refund of all federal income tax withheld last year because you had no tax liability.
2. You expect no federal income tax liability this year.
To claim exemption, write “Exempt” on Form W‑4 and submit it to your employer. The exemption must be renewed each year; it does not carry over automatically.

When to update your W‑4

File a new Form W‑4 with your employer whenever your personal or financial situation changes, such as:
– Marriage or divorce
– Birth or adoption of a child
– A spouse starting or stopping work
– Significant changes in other income or deductions
Employers must put the new withholding into effect no later than the first payroll period ending after 30 days from receiving your revised form (they may implement it sooner).

You can also ask your employer to withhold an additional flat dollar amount if you expect a tax shortfall (for example, because of year‑end bonuses or investment income).

If too little or too much is withheld

• Too little withheld: You will likely owe tax when filing and may face penalties for significant underpayment. You can increase withholding by submitting a revised W‑4 or arranging estimated tax payments.
• Too much withheld: You receive a refund when you file, but that means you gave up use of that money throughout the year.

The goal is to set withholding as accurately as possible to avoid large balances due or unnecessarily large refunds.

How employers calculate withholding

After receiving a completed W‑4, employers (or payroll software) calculate withholding for each pay period. Employers can use payroll systems with built‑in withholding calculators or consult IRS Publication 15‑T (Federal Income Tax Withholding Methods) for guidance.

Key takeaways

• Withholding allowances tied to personal exemptions were eliminated by the TCJA for tax years 2018–2025; they no longer appear on Form W‑4.
• Form W‑4 remains the mechanism to set federal income tax withholding; it now focuses on jobs, credits, and other income rather than allowances.
• Update your W‑4 whenever your circumstances change and use the IRS Tax Withholding Estimator to check accuracy.
• You can claim exemption from withholding only if you had no tax liability last year and expect none this year—and you must renew the claim annually.