By Stacey Ritzen, WCI Contributor
Everyone, regardless of wage or position, must fill out a W-4 form to submit to their employer when starting a new job. In addition to being a commonality that we all share, the W-4 is a crucial tool to ensure that we’re paying the correct amount of taxes and that we won’t be hit with a financial surprise when tax season rolls around. Naturally, this is also why it’s necessary to fill out your W-4 form correctly.
Yet, for many people, there remains an element of confusion when it comes to filling out their W-4 form, which is why we’re here to walk you through the process.
What Is a W-4 Form Used For?
The W-4 form, aka the “Employee's Withholding Certificate,” lets employers know how much money to withhold from an employee’s paycheck and then passes that money along to the Internal Revenue Service (IRS). So, instead of owing the federal and state governments a huge lump sum on Tax Day, those income taxes are paid gradually throughout the year.
Why Do I Have to Complete a W-4 Form?
The IRS requires everyone earning a wage or salary to pay taxes as they go. Taxes can be paid either by making quarterly estimated tax payments during the year or, for most people who aren't self-employed, regular withholding from their paycheck.
Along with not owing a colossal tax bill when it comes time to file a return, paycheck withholding can also help avoid interest or penalties for paying too little tax during the year (yes, the IRS does issue penalties for not paying enough as you go). Generally, you can avoid getting penalized by paying at least 90% of your taxes throughout the year (100% for high earners). There are two other ways to ensure you're in the “safe harbor” that allows you to avoid penalties and interest.
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The Difference Between Taxes Due and Taxes Withheld
It is important to understand the difference between the amount that must be withheld and the amount that must be paid. These are not the same things. Sometimes more is withheld than must be paid, and at other times, less is withheld than must be paid. These two numbers are reconciled when you file your tax return. But the rules for how much must be withheld by an employer are not the same as the rules that dictate how much must actually be paid. The W-4 is about the withholding rules, not the actual tax payment rules. At the end of the day, the payment rules are the ones that really matter.
How Do I Fill Out My W-4 Form?
To fill out your W-4 form, you will need to share your personal information, including your name, address, Social Security number, and tax filing status. Your tax filing status pertains to whether you identify as single or married filing separately, married filing jointly or a qualifying widow(er), or as head of household. The latter means that you’re unmarried and pay more than half the costs of keeping up a home for yourself and a qualifying individual.
That’s the easiest part. In steps 2 through 4, you will need to provide information on your spouse's earnings, show whether you have additional income from a second job or self-employment, and claim any dependents. You may also need to make adjustments (such as additional income not from jobs), any deductions other than the standard, and any additional withholding you would like the IRS to take.
If you’re single or have a spouse who doesn't work, have only income from one job, and have no dependents, filling out the W-4 form is as easy as providing that initial basic information. Things get more tricky when you factor in multiple wages and dependents. Fortunately, the IRS offers an easy-to-use online Tax Withholding Estimator to help determine the amount you would like to be withheld from your paycheck.
Should My Spouse and I Both Claim Dependents?
If you are married filing jointly and you and your spouse have dependents, it’s generally advised that the partner with the higher-paying job claim dependents. If both partners claim child-related tax credits on their W-4 form, you may not allow for enough withholding. That means you could owe money at the end of the year or, worse, face a penalty.
Should I Claim an Exemption from Withholding?
There are not many reasons to claim an exemption from withholding taxes from your paycheck—unless, for some reason, you are legally exempt because you had no tax liability for the previous year and likewise expect to have no tax liability for the current year. Again, even if you did claim an exemption from withholding, it would just mean you’d have to pay all your taxes in one lump sum in addition to any fees or penalties.
What Is Part-Year Withholding?
There are some instances, however, in which you may ask your employer to use part-year tax withholding to calculate your taxes if you are employed for fewer than 245 days of the year. For example, if you’re starting a job in the middle of the year or you will only be employed for a few months, the standard withholding would take more money out of your paycheck based on the entire year’s wages.
If you choose not to adjust your withholding, you’ll have less money in your paycheck but will ultimately get a larger refund at the end of the tax year.
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Why Shouldn’t I Have More Tax Withheld and Receive a Big Refund at the End of the Year?
Some people enjoy having a windfall during tax season by having more money withheld from their paychecks throughout the year. Technically, there’s nothing wrong with doing this, but there are a few reasons why it’s not an ideal situation.
First and foremost, that’s your money. By allowing Uncle Sam to take more of it, you’re essentially providing the government with an interest-free loan when that money could be spent or invested more practically during the calendar year. In a practical sense, many people also spend money more recklessly when receiving a big check all at once. Sure, that check might conveniently arrive when your water heater goes belly up or when a large medical bill arrives in the mail but you also might be tempted to splurge on, shall we say, less necessary purchases.
How to Have More Taxes Taken Out of Your Paycheck
If you would like more taxes withheld from your paycheck—whether to receive a larger refund on Tax Day or to compensate for other income for which nothing (or just not enough) is being withheld—it’s as simple as filling out Step 4 on the W-4 form to make additional adjustments. You can allow for extra income for other jobs or enter any additional tax you want to be withheld from each pay period. Note that this strategy can help your cash flow. While the government cares when you pay your quarterly estimated tax payments, they treat money withheld by an employer in December exactly the same as money withheld in January.
How to Have Less Tax Taken Out of Your Paycheck
Similarly, Step 4, section (b) on the W-4 form allows you to claim any deductions other than the standard to reduce your withholding. Page 3 of the form includes a Deductions Worksheet to help you calculate—but again, be careful not to withhold too little, or you might get hit with a penalty.
How to Use a W-4 to Owe Nothing on a Tax Return
If you don’t want to get surprised with a bill on Tax Day, fill out your W-4 form as accurately as possible with the correct tax-filing status, ensure that any dependents are accounted for, and estimate any other sources of income or deductions. You can also use the last line on the form for additional withholding to give yourself some breathing room—but if all the other information is calculated correctly, it’s unlikely you’ll need it.
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What’s the Deal with W-4 Exemptions and Allowances?
The IRS provides dependent exemptions to give tax breaks to those with children or other family members without income, which is subtracted from your Adjusted Gross Income (AGI) on your tax return. However, the way we claim exemptions on the W-4 form has recently changed.
Before 2020, the amount of tax withheld was calculated in allowances, in which you entered 0, 1, or 2 on your W-4 form. Entering “0” for allowances meant that the most amount of money was withheld from your paycheck, and “2” ensured that the least amount was. For example, a single person could claim a “1” allowance and likely receive a modest refund at the end of the year.
But when the Tax Cuts and Jobs Act of 2017 reduced tax rates for many Americans, the IRS likewise reduced the amount of tax withheld from wages to reflect the changes. Unfortunately, this slight overcorrection caused many people who ordinarily received tax refunds to owe money at tax time instead. As a result, the IRS introduced a new W-4 form in 2020 that eliminated allowances and replaced them with line item dollar amounts for deductions and withholding.
When to Update Your W-4 Form
You can update your W-4 form at any time to adjust the amount of money being withheld from your paycheck. For example, you can do it when you're preparing your annual tax return and you realize that you simply withheld too much or too little the previous year.
If you’re experiencing any major life events—such as getting married, divorced, starting a second job, having a child, or if your number of dependents changes (because, for instance, an adult child leaves home)—that will impact how much in taxes you owe to the government. While there’s no set deadline to update your W-4, most experts would recommend doing so within 10 days of any significant life events.
If you need help with tax preparation or you’re looking for tips on the best tax strategies, hire a WCI-vetted professional to help you figure it out.
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