What is Underwithholding?

Usually, there is an amount of money that an individual pays as tax to the government for a particular year, tax can be deducted from the individuals wage or income. Failure to make the adequate tax payment during a year is a punishable offense. Underwithholding refers to a situation in which a taxpayer pays an inadequate amount of taxes for a particular year. When an individual withholds an insufficient amount that does not cover tax owed for a year, underwithholding has occurred.

Back to: Accounting & Taxation

How Does Underwithholding Work? 

Inadequate payment of taxes for a particular year, whether deliberate or in-deliberate is underwithholding. Usually, an individual is meant to withhold or separate a part of their income or wage for tax payment, failure to withhold a sufficient amount that will cover tax payment or tax owed for the year is underwithholding. Failure to pay taxes appropriately results in an individual owing taxes and owed taxes are paid by the individuals withholding a part of their income or wages. When the taxpayer then withholds an amount that is insufficient to cover the taxes owed for a year, it is known as underwithholding. Too much of underwithholding can attract unpalatable penalties that every individual should avoid.

Why Would an Individual Choose to Underwithhold?

Many individuals have different reasons for underwithholding their taxes. Although, none of these reasons is justifiable, especially when the act attracts a sanction. For some taxpayers, especially those into personal businesses, they might withhold taxes for investment purpose. They want to realize returns from the amount to be paid as tax before they make the tax payment, so they underwithheld. Also, some taxpayers deliberate withhold their taxes so that they can make gains from it. These categories of people withdraw the amount meant for tax and deposit it in a separate account so that it can generate interest rather than they paying to the government as tax.

Underwithholdings Opposite: Overwithholding and its Benefits

The direct opposite of under withholding is overwithholding. When a taxpayer over withholds. Overwithholding happens when a taxpayer deliberately withholds an amount of money higher than the amount of tax they are likely to owe for a year. The major benefit of overwithholding is that taxpayers are entitled to a refund of the excess amount once a tax report has been filed.