Since World War II, the federal government has required taxpayers to make payments throughout the year through tax withholding and estimated payments, rather than just making one lump sum at tax time. Knowing who fills out a W-4 and what is the purpose of the W-4 form allow you to plan for your tax liabilities more effectively and avoid penalties for having too little withheld throughout the year.
The Form W-4 is used to help your employer know how much to withhold from your paychecks for the taxes that you’ll owe at the end of the year.
What Is the Purpose of Filling Out a W-4?
The purpose of filling out a Form W-4 is to help your employer determine how much money to withhold from your paychecks. Your withholding is figured using a formula that takes into account three factors; your income, your filing status and the number of allowances you claim. Your employer already knows your income, because only the income from that particular employer is considered when determining how much the employer withholds. However, you need to supply the remaining information, which is your filing status and allowances. If you don’t fill out a Form W-4 for your employer, your employer will withhold income taxes at the highest rate, which is as if you are single and you claim zero allowances.
Selecting Your Filing Status
On the Form W-4, you have three options when it comes to your filing status; single, married and married but withhold at the higher single rate. If you’re not married, you only have one option because it’s illegal to lie on your Form W-4. But if you’re married, you need to think about which option best suits you.
The married option allows your employer to withhold taxes at a lower rate because the income tax brackets for married couples filing a joint return are larger than the tax brackets for single people. So if you’re the sole wage earner in your household, this option will usually be more accurate in making sure your withholding mirrors what you owe in taxes.
On the other hand, if you and your spouse plan to file separate income tax returns, you’re better off selecting the married, but withhold at the higher single rate because the tax brackets for married people filing separately are much lower than for married couples filing jointly. If you choose just the married option, but then file separate returns, your withholding could be substantially lower. You might also choose the married, but withhold at the higher single rate if you prefer to receive a large tax refund when you file your return at the end of the year.
Effect of Withholding Allowances
The other information that you must provide on your Form W-4 is the number of allowances you are claiming. Each allowance that you claim reduces the amount of your tax withholding by a certain amount over the course of the year, and your employer will spread that amount equally over each pay period. For example, if you get paid monthly, your employer would reduce the amount of each paycheck subject to withholding by one-twelfth of the annual value of a withholding allowance. The more allowances you claim, the lower your tax withholding will be. If you’re wondering “What does it mean if you claim 0 on your W-4?” it means that all of your income will be included when calculating your withholding.
Calculating Allowances to Claim
The Form W-4 has three different worksheets that you can use to calculate how many allowances you should claim. If you plan to claim large deductions on your taxes, such as traditional IRA contributions, student loan interest, charitable contributions, state and local taxes and mortgage interest, or if you have substantial nonwage income, you should use the Deductions, Adjustments and Additional Income Worksheet.
If you’re married and both of you work, or if you work multiple jobs, you should fill out the Two-Earners/Multiple Jobs Worksheet. This worksheet will tell you how many allowances to claim on the Form W-4 for your highest-paying job. You should report zero allowances on your remaining jobs.
If those situations don’t apply to you, you can use the straightforward Personal Allowances Worksheet, which tells you how many allowances to claim based on your filing status and eligible child tax credits. Of course, you can always claim fewer withholding allowances than you’re allowed if you prefer to receive a larger tax refund.
Penalties for Underwithholding
If you don’t have enough money withheld from your paychecks during the year, the IRS imposes additional tax penalties and interest on the amounts that you should have paid in, but didn’t, on top of having to pay the difference when you file your tax return.
The IRS has several requirements that you can meet to avoid owing a penalty for income tax withholding. You only need to meet one of them to avoid owing a penalty. But if the safe harbor that you opt for doesn’t require that you pay in at least as much as you end up owing for the current year, you will still have to pay the extra at tax time, just not any additional interest or penalties.
First, you won’t owe any penalties if the amount you owe when you file your taxes is less than $1,000 after counting any tax withholding and estimated tax payments that you made during the year. For example, if you had $300 withheld from your paychecks and your tax liability is $1,100, you only owe $800, so there’s no penalty.
Second, you won’t owe a penalty if your tax withholding and estimated tax payments during the year equal at least 90 percent of your tax liability for the year. For example, if your tax liability for the year is $7,000, you need your withholding to be at least $6,300 to avoid a penalty. However, if at least 66 2/3 percent of your income comes from fishing or farming, you can meet the safe harbor as long as you’ve paid in at least 66 2/3 percent of your tax liability. If you file jointly, that 66 2/3 percent requirement refers to all income from both spouses, so if you both earn equal amounts of income and only one spouse has income from farming or fishing, you’ll need to hit the 90 percent threshold.
Third, because it can be hard to predict your income for the year, the IRS has a safe harbor based on your income tax liability from the previous year. Most taxpayers will satisfy this safe harbor as long as their income tax withholding and estimated tax payments equal at least 100 percent of their tax liability from the prior year. But if your adjusted gross income for the prior year exceeds $150,000 (or $75,000 if you’re married filing separately), the threshold increases to 110 percent of what you owed the prior year.
For example, if your adjusted gross income last year was $80,000 and you had a $5,500 tax liability, you would need at least $5,500 in withholding and estimated tax payments to avoid a penalty. Even if this year you ended up making twice as much and having a tax liability of $12,000, you wouldn’t be penalized for underwithholding as long as you had at least $5,500 withheld.
Impact of Overwithholding
If you have too much money withheld from your paychecks, the good news is that the IRS won’t penalize you for paying too much. Also, you’ll receive all of the excess back when you file your income tax return at the end of the year. So if you had $3,000 extra withheld from your income during the year, you'd receive a $3,000 refund when you file your tax return. Also, you may find that overwithholding helps you to save more money throughout the year because you don’t have access to the excess.
The downside to overwithholding is that, in essence, you are making an interest-free loan to the government. For example, say you have an extra $300 withheld from each monthly paycheck during the year. When that $300 extra is withheld from your January paycheck, you won’t be able to access it for over a year. And when you do get it back in the form of your tax refund when you file your tax return the following year, you won’t have earned any interest on it. Meanwhile, if you have outstanding debt, such as credit card debt, you will still be paying interest to those creditors while the government isn’t paying you any interest on the money you’ve functionally “lent” to it.
Filing a New Form W-4
The purpose of a W-4 form is to make sure that your withholding is accurate so that you don’t have too little, or too much, withheld from your paychecks for taxes. However, if your life changes and you don’t change your Form W-4 with your employer, your withholding could be significantly off. For example, you should file a new Form W-4 when you experience major life events, such as getting married or divorced, having a child or you or your spouse getting new jobs, working on the side or having investment income.
You can submit a new Form W-4 to your employer any time you want, and as many times per year as you wish. Your employer has until the pay period that starts on or after the 30th day following your submission of the new Form W-4. For example, say you turn in a new Form W-4 on April 1. Your employer must use the new information to calculate your withholding starting the first pay period that begins on or after May 1. Of course, there’s no limit to how quickly your employer can get the new information entered, so it could even apply to your next paycheck.
2018 Tax Withholding Changes
The biggest change to tax withholding in 2018 is the change in the income tax brackets. Under the Tax Cuts and Jobs Act, which takes effect in 2018, the income tax brackets have been lowered. Now, the top tax bracket is 37 percent, and most of the lower brackets have also been reduced by a few percentage points. Also, the standard deduction has increased substantially, so the formulas for calculating the right amount of withholding have changed. The 2018 standard deductions are up to $12,000 for singles and each spouse when filing separate returns, $18,000 for heads of household and $24,000 for couples filing joint returns. Also, the value of each withholding allowance claimed reduces your income subject to withholding over the entire year by $4,150.
2017 Tax Withholding Rules
In 2017, the highest income tax bracket was 39.6 percent, and the standard deductions were about half of what they were increased to for the 2018 tax year: $6,350 for singles and each spouse when filing a separate return, $9,350 for heads of household and $12,700 for couples filing a joint return. The value of each withholding allowance in 2017 was $4,050.
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