Everything You Need to Know About Retention Tax

What is retention tax?

Also called tax withholding, retention tax is the money kept back by the payment source. This money should cover one's tax requirements. The party that retains it is either the employer, the government, or any source of payment.

The best retention tax examples are Pay-As-You-Earn (for permanent salaries) and Pay-As-You-Go (for temporary wages). When employers retain tax money from their employees' payrolls, then channel that money to the tax collector; this is retention tax. In the US, the IRS receives all tax withholding.

Another way to define retention tax is the duty paid to the government (that is, the IRS) directly from the income payer rather than the income recipient.

Countering tax evasion

If you asked most employees, they do not understand why retention tax exists. Most of them may feel like it is a stringent law, that only cuts back on their income. Besides, they surely can be trusted to pay their own tax without having it be cut even before they see it. However, tax withholding serves a very core purpose, especially in dealing with tax evasion.

One thing the IRS saves taxpayers when dealing with receiving tax withholding is the painful dilemma of decision-making. They know that once employees get their hands on their full salary, it might be an uphill task getting them to pay their taxes, which will ultimately lead to more cases of tax evasion. Tax is not an enjoyable thing to pay, and retention tax helps reduce the complexities that would have otherwise undermined the process.

Tax returns

Tax returns include income and expenses so that the relevant authority calculates tax liability and creditworthiness. Tax returns are filed with the Internal Revenue Service (IRS) in the United States.

In some instances, tax may be retained in advance. Instead of deducting it annually, it could be done periodically and prior. A taxpayer could submit a request to have their tax refund processed.

Employee Retention Credit (ERC)

When employees receiving salaries, that is, are on a payroll, get a credit on their expected tax, this is referred to as an Employee Retention Credit. However, this subsidy only ran from March to December 2020. This was aimed to cushion employees from the ravages of the COVID-19 pandemic.

The only requirement to be eligible for an ERC is proof that one's business has been adversely affected by the pandemic. One might be required to provide financial reports comparing 2021 earnings with those in 2020 or 2020 with 2019's. Self-employed individuals cannot claim an ERC.

Who pays retention tax?

The clear answer to this would be employers and for their employees' sake. Well, this is far from the truth. While employers are required to pay payroll tax, one of the most popular types of retention tax, there are other avenues that some governments use to obtain the same. These subcategories include:

National vs. Foreign National

A citizen of a country pays the tax withholding required by the tax authority of their country. All rules and requirements set by the authority should be granted and followed by the individual. For the foreign national, however, things may be a little different. Basically, if the employee's postal address is not domestic or their nationality is known to be international, tax withholding is paid at a specific rate.

Single vs. Married

Single individuals can file their returns individually or as the head of the household if they care for a qualifying individual. Pooling one's tax withheld with a spouse means less tax retained. One is given the option of either filing their returns separately or jointly as a couple.

Joint married file returns have a lower percentage than single returns. In case a single's marital status changes during a financial year, they will be required to fill out a new W-4 form for the updates to be included in the next year.

Purchasing real property

In the US, for example, every individual who purchases a real property must pay a 15% tax withholding. The government relinquishes all rights to the individual to lease, sell, rent, or improve the land. Real properties sold in Canada fetch up to half the original price as retention tax.

W-4 Form

Sometimes, an employer may run some background checks before hiring an employee. In the midst of these files, one is most likely to find a W-4 form. What this form does is to state the employee’s tax state. It is the employee who is required to fill this form. This form is also referred to as the Employee’s Withholding Certificate.

The employer is then at liberty, and of course bound by the prevailing laws, to deduct tax depending on what the employee filled in their W-4 form.

The form is solely handled by the IRS, which also ensures the seamless change of the document in case the taxpayer’s life choices have changed, such as marriage, or when inevitable changes have come, such as the death of a spouse.

Pros and cons of retention tax

Retention tax stands as a star in the murky world of taxes and levies. The reason? All adults who have worked in their lives or are working have experienced it in one way or another. Tax withholding has shone through almost every payroll ever printed. Not everyone likes it, but it helps tax authorities regulate taxes.

The advantages lean more towards the tax collector than the taxpayer. However, not all is dark and gloomy. Retention tax is beneficial for the taxpayer because this money is used for national development. Roads are built, and schools and hospitals receive supplies, among many more benefits. Most federal and state projects would be utterly crippled if citizens did not pay taxes.

A disadvantage of retention tax is its underhand nature. People feel as if they have been ripped off. New entrants to the employment scene may find it extremely difficult to understand the considerable difference between their gross pay and net pay. Settling in is a challenge. For older employees also, the challenge is real; having money cut off from one's pay slip is not fun in the slightest.

The IRS also has to continue expanding its tax collecting strategies so that filing returns is a seamless process for taxpayers. Herein lies a diseconomy of scale. Tax collection should not contain errors and be a smooth and unflawed digital process. Ensuring and maintaining this is a priority task for every tax collection service.