What is a Withholding?

Definition: Withholding is an operation in which money is deducted from a payment issued to a third party. To sum up, it means a discount made to a given payment.

What Does Tax Withholding Mean?

Withholding is a business term that commonly indicates a tax-related transaction. It normally takes place when an employee is getting paid and the company withholds a portion of its payment to meet federal, state or even municipal tax commitments. This is a mandatory practice for US businesses, according to the current tax law, since it helps the government get periodical payments rather than getting all of them by the end of the year.

This also helps individuals to pay taxes on a prorated basis, helping them to avoid getting unusually-high tax bills at the end of the year. Some bank and brokerage accounts also withhold taxes from clients if they are receiving income in their accounts. In the case of banks, they can withhold a portion of the interest paid to the account holder; and in the case of brokerage accounts, there might be a withholding tax when a dividend payment is received.

Here’s an example.

Example

Mr. Spencer was recently hired at a company named Double B Communications LLC. His job contract says he earns a gross salary of $3,500 a month. According to his individual evaluation, required by the current tax laws, the company has to deduct 6% of Mr. Spencer gross pay. The total amount being deducted from his paycheck would be $210 a month. Is this a withholding transaction?

As we previously stated, withholding is an operation in which money is deducted from a payment issued to a third party, regularly for tax purposes. As we see in this scenario, the company is deducting a percentage of Mr. Spencer money to withhold taxes on behalf of the federal government. This means the transaction can be considered as a withholding.