If you have a traditional job in the United States, you work for a company. They are the “employer,” and you are their “employee.”
You receive compensation for your time and productivity in this employer-employee relationship. Most people are paid weekly, twice per month, or monthly.
When you receive your paycheck, you’ll notice that the employer deducts a certain amount from the gross wages in different categories. These funds are paid directly to the government.
This amount is kept on a register with your name at the IRS as a “tax withholding.” You’ll usually see it associated with Code 806 when you e-file your annual returns.
IRS Tax Code 806: What Does Code 806 Mean on IRS Transcript?
IRS Tax Code 806 acknowledges that an individual has filed their return electronically with the agency. It also represents how much was withheld from a taxpayer’s income during the year from their employer. This figure is different than what independent contractors send to the IRS when paying estimated taxes for the year.
The United States uses a pay-as-you-go taxation system. Once you earn enough money, the government expects to have you send the percentage due to them immediately. If you have traditional employment, your employer does this for you each time a paycheck is issued.
The amount the employer deducts from an employee’s paycheck is then itemized on the pay stub. This figure is found on the annual W-2 form that offers wage and tax statements when it is time to file the annual income tax return.
Self-employed individuals follow the same process, but they must act as their own employers. Most people pay estimated taxes from income they earn in this non-traditional format four times per year: April, June, September, and January.
How Much Gets Deducted from My Paycheck?
The amount the government takes from an employee’s paycheck each time depends on several factors. Your earnings, filing status, withholding requests or allowances, and garnishments play a role in what eventually gets deposited into your account or issued as a check.
If there is too much of your income withheld at the end of the year, the IRS issues a refund to the taxpayer. This action settles their account.
The goal should be to have the exact amount withheld for each check to avoid giving the government an interest-free loan. Although it’s nice to get that lump-sum payment each year, that’s still the money that you could have already had to use at your discretion.
It helps to check your withholding tax at least twice per year to ensure its accuracy. You’ll also want to review your income circumstances whenever lifestyle changes occur or your deductions and credits change.
The best time to review your withholding allowances is when you get married, file for divorce, or add a dependent to your family. You’ll need to check on this amount whenever you have significantly more or less income available to spend.
Most states collect income tax. The withholding systems for this obligation are similar to what employers manage for the federal government. You’ll see these figures itemized on your paystub, but they won’t typically be part of IRS Code 806 because it is a local, not a national-level obligation.
Nine states currently don’t have an income tax to manage: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming.
- New Hampshire residents pay income taxes on dividends and interest income, but not on wages they’ve earned through traditional or self-employment.
- Washington residents do not have a withholding tax unless they fall into the high-earner category and have capital gains to report.
- Self-employed individuals might not have withholding taxes to pay, but they might be asked to pay business-related taxes from their activities.
In Washington State, a self-employed individual must have a business license to provide services in most communities. Some exceptions apply if the income levels are less than $12,000. Most individuals won’t pay any business and occupation taxes from their income if they make less than $50,000 per year with the available credits.
Withholding Taxes Started During the Civil War
President Abraham Lincoln is known for a lot of things, but his actions to install the withholding tax are often forgotten. The goal of this fundraising effort was to ensure there was enough money to battle the Confederacy during the Civil War.
The government also used excise taxes to fund the war effort in the 1860s. These financial responsibilities were abolished in 1872.
A large tax hike was implemented in 1943 to support the military efforts in World War II, which caused the current withholding system to be in place. The government thought it would be difficult to collect these new taxes if they had to go to the individual or family. Employees fill out a W-4 form when they’re hired to estimate the amount that is due.
Two types of payroll taxes in the United States are subject to this withholding. Outside of the payroll tax, you also have the contributions to Social Security, Medicare, and federal unemployment programs. These are broken into resident and non-resident categories.
What Happens If I Fall Behind on My Taxes?
The IRS levies an underpayment penalty on taxpayers if they don’t have enough of their income withheld during the year from their wages. This issue also applies to those who pay late or don’t send in enough money for their quarterly estimated taxes.
The easiest way to avoid this fine is to pay either 100% of last year’s tax obligation or 90% of the current year’s taxes.
Individuals with an adjusted gross income of $150,000 or less must pay the lesser of 90% of the current year’s tax or match the previous return’s obligations. Those who make more than that amount must pay either the 90% or 110% commitments of the prior taxable year.
For those who report self-employment income, their Medicare and Social Security liabilities should be included in that amount.
The underpayment failure-to-pay fine cannot be more than 25% of the unpaid amount. It’s not a static percentage or a flat amount.
This penalty is based on several things, including the total underpayment amount, the period where the taxes were underpaid, and the federal short-term interest rate for the year.
Most people owe 0.5% of the amount that wasn’t paid for each month or part of the month that the money wasn’t forwarded to the government. That figure then gets hit with an interest percentage, which was 5% for individuals and 7% for corporations that exceeded obligations of $100,000, in the third quarter of 2022.
What to Expect from an Underpayment Penalty
Most taxpayers won’t receive an underpayment penalty, but it can happen if the withholding tax from Code 806 doesn’t satisfy the overall obligation. It tends to be an issue for those reporting self-employment income.
Imagine that you owe $7,000 in taxes for the year, but you only paid $1,000 in your scheduled estimated payments. When it is time to file the return, you’ll end up owing $3,000, which should have been paid earlier.
If the amount is more than $1,000 and you didn’t pay at least 90% of what you owed or 100% of last year’s obligation, the amount would be subject to the underpayment penalty. For the third quarter of 2022, that would be a fine of $150 that gets added on top of what you still need to pay.
Transcript Code 806 Does Not Waive Taxpayer Obligations
The best way to ensure nothing is owed to the government is to have accurate amounts withheld. IRS Code 806 doesn’t relieve an individual or a business of their payment obligations for each reportable period. To avoid this issue, owe less than $1,000 for the year or pay the lessor of 90% of the tax obligation or the entire amount from the previous year.
The Internal Revenue Service can decide to waive the underpayment penalty for several reasons.
- You weren’t a resident or a citizen for the preceding tax year, which means you didn’t owe anything.
- There was a casualty event, unusual circumstance, or natural disaster that interrupted your ability to make one of your estimated payments.
- The IRS determines the underpayment issue is not willful neglect, such as your employer withholding the incorrect amount while you’ve filed the correct paperwork.
- You became disabled during the tax year when estimated payments were owed.
- You’ve decided to retire after reaching age 62 in the current or previous tax year.
If you don’t pay enough in your taxes, including withholding and estimated obligations, you could end up sending even more of your income to the government. For those who do get charged a fine, it might be possible to qualify for a reduced amount or a 100% exemption.
The best way to avoid issues with Tax Code 806 is to review your withholdings and payments periodically to ensure their accuracy.
