What are Tax Allowances? - Definition & Rates

Instructor: Ian Lord

Ian has an MBA and is a real estate investor, former health professions educator, and Air Force veteran.

In this lesson, we will discuss what tax allowances are, and how claiming the right number of allowances ensures that an appropriate amount of taxes are withheld from employee paychecks.

Tax Allowances

Tom is going through orientation at his first job. As part of the paperwork, he is given an IRS form to determine how many allowances he will claim as part of his payroll withholding. Let's help Tom understand what an allowance is and how it affects his take-home pay and tax return.


In the US tax system, a taxpayer's bill is influenced by many factors other than just his pay. If Tom is married or has dependents, his tax bill would be different than if he were single and had no children. Employees such as Tom pay income taxes throughout the year through payroll withholding, a process where the employer sets aside money from a paycheck and sends it to the IRS on the taxpayer's behalf. Tom wants to make sure that enough money is being withheld to cover his tax bill, but not so much that his take-home pay drops more than it has to. This is where allowances come in.

An allowance lets the employer know how much money to withhold. The employer calculates the amount of taxes to be withheld based on the amount of money an employee makes in a year. But because the tax code offers deductions to reduce the taxpayer's taxable income, the amount that needs to be withheld changes from person to person. For the tax year 2017, each allowance claimed tells the employer not to withhold taxes on $4,050 worth of pay. If Tom claims the right number of allowances, he should neither owe or be due a significant amount of money when he files his taxes.

Form W-4

The form Tom uses to let his employer know about how much to withhold is the IRS Form W-4. It has two main components: a certificate that remains on file with the employer, and worksheets for Tom to figure out how many allowances he should claim. Allowances can be added up on the worksheet to determine how many should go on the certificate. If Tom ever expects anything to change regarding his taxes, he can change his withholding any time by giving his employer a new Form W-4.

For example, Tom could claim an allowance for himself, since his parents can't claim him as a dependent. He also claims one for his wife and and another for his child. He can claim additional allowances because he expects to claim a tax credit for childcare expenses. If Tom's tax situation is more complex, such as a case where he itemizes his taxes instead of taking a standard deduction, or between him and his wife, the household tax return shows income from multiple jobs, the back of the form has alternate worksheets that account for even more of these variables.

Form W-4

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