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Withholding and Estimated Tax

In the United States, income tax is paid on a “pay-as-you-go” basis. If you work for someone else, a certain portion of your pay will be subject to “withholding,” and sent by your employer to the federal and state governments. There will also be deductions for F.I.C.A. (social security tax), unemployment insurance, and for various other mandatory government programs. The remainder is referred to as “take-home pay”. For a wage earner who is “on the books,” take home pay can be distressingly small.

If you work for yourself, you will be expected to make estimated tax payments in advance to the IRS and state tax department every three months. If you don’t make these advanced, estimated tax payments, you will be subject to a financial penalty, even if you pay all the tax due at the end of the year. Remember that ignorance of the law is no excuse.

The plus side to withholding and estimated tax, of course, is the fact that when time comes to file your tax return, which you must do, you will have already paid the tax due, or in fact even be entitled to a refund. This system is convenient for most people because they do not have to worry about spending money they need to be allocating to later tax payments. Few people realize, of course, that their periodic payments are, in effect, an interest-free loan to the government.

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