One small document that significantly impacts your tax season is the W-4.
Whether you’re making adjustments to your withholding at a current job or beginning a new career, understanding this document can ensure that you save as much money as possible.
Ironically, as money is a top stressor for so many people, many employees are actually paying the government more in taxes than they need to by not properly filling out their W-4 forms. By getting the W-4 right, you could increase your take-home pay.
We’ll walk you through the entire thing.
What is a W-4
The W-4 form is also called the Employee’s Withholding Certificate. Your employer uses this form to determine how much money to keep from your paycheck for state, local, and federal income taxes. You’ll always fill out a W-4 when you start a new job. Other times you may need to refill out the form include if you get a big raise, have more children, get married, or get divorced. The IRS suggests filling out a new one each year to make sure you’re staying on top of the amount of taxes you owe. But in all my jobs, I’ve never seen anyone do this.
Fill out a W-4 when you start a new job or when you have a major life event like marriage or a new child. Otherwise, don’t worry about it.
Your employer will ask that you fill out the W-4 form before your first check. If the form isn’t completed and turned into your employer beforehand, they’ll likely process your check as if you’d filed for 0 allowances. You can always update this information throughout the year.
When filled out properly, the W-4 lets you bring home as much of your paycheck as possible without owing a bundle of money during tax season.
Information You’ll Need to Provide On a W-4
The W-4 is a very short form. While the document you receive is around four to five pages, you only have a few lines to fill out yourself.
The information you’ll need to provide includes:
- Full Name
- Marital Status
- Declaration of multiple jobs
- Declaration of a working spouse
Your employer will take the information you provide, then add their employer identification number and the date you started working with your company.
Additional pages included in the W-4 are the personal allowance worksheet, deductions and adjustment worksheet, and two-earners/multiple jobs worksheet.
- Personal allowance worksheet: The personal allowance worksheet tells you how many allowances you could take. Use this worksheet to determine which allowance options are best for your family. We’ll discuss personal allowances in the next section.
- Deductions and adjustments worksheet: You only need to worry about this form if you plan to itemize your tax deductions. Most people opt for the standard deduction, but some people may save more money on taxes by opting to itemize. You’ll need to provide an estimate of your potential deductions on this form.
- Two-earners/Multiple jobs worksheet: If you have two jobs or your spouse also works, this form will help you determine how much money to withhold from your check to account for the second income. This can be a very useful tool for couples who are filing joint tax returns.
Making Sense of Allowances
The purpose of your W-4 form is to tell the employer how much money to hold back for taxes. Allowances tell your employer that your taxes will be less so there’s no need to withhold as much. This reduces the taxes that are taken out of each paycheck and increases the amount that hits your bank account.
If you claim zero allowances your employer will withhold the maximum amount allowed based on your tax bracket, filing status, and paycheck frequency.
Taking too few allowances means you overpay. While overpaying taxes could result in a larger tax return, that’s also less money you have available to spend the rest of the year. Be careful though, taking too many allowances means you could end up owing the IRS more money and having to pay a penalty.
Each individual qualifies for a single allowance. So, a college student who is dependent on their parents’ taxes could claim 0 or 1. If you’re single with one job and you don’t qualify as a dependent on anyone else’s taxes you could take 1-2 allowances. If you take two, you may owe a little money at the end of the year.
Married couples can claim one allowance for each dependent. You can also add an additional allowance if you will claim the child tax credit.
Note: If you have multiple jobs, you should split the number of allowances between both jobs. If you have two jobs and three allowances, put 3 allowances on your primary job and 0 allowances on your second job.
There are some situations in which you may qualify for additional allowances if you plan to itemize your deductions. New laws increased the standard deduction, so itemizing may not be your best option. If itemizing your deductions will help lower your tax bill, you may be able to add allowances to your W-4. Use the Deductions and Adjustments Worksheet included with your W-4 to determine if this is the best option for you.
Some individuals may qualify for a tax exemption. This means that your employer cannot hold any funds to pay towards taxes. To qualify, an individual or couple must expect their total annual income will result in zero liability. This means that you qualified for all of your withheld federal taxed income as a return in the previous year and expect the same for the current year.
W-4 Vs. W-2
While both the W2 form and a W4 form are concerned with payroll, their functions are completely different.
Where a W-4 tells your employer how much money to set aside for federal, state, and local taxes, the W-2 tells the employee how much they earned, how much they paid in taxes, and where other deductions went (Medicaid, health insurance, Union dues etc.). The W-2 gives a complete summary of everything you were paid along with your taxes at the end of the year.
The information used on the W-4 will affect the information you receive on the W-2, which is why understanding allowances is important. Once you submit your W-4 to your employee, you begin work and start getting paid. Your company gives you a paycheck each pay period (minus any tax and retirement deductions) and then supplies you with the W-2 form at the end of the year to detail your annual financial report.
If you have a higher number of allowances, you’ll bring home more in each paycheck. If you take fewer allowances, you’ll bring home less money each check.
Things to Know and Tips to Consider
Updating your W-4 with some regularity can affect the amount of tax you owe. You should always update your W-4 after major life events, especially a marriage, new job, or the birth of a child.
Another way to simplify your taxes is to consolidate your allowances. If you and your spouse both work and have multiple jobs, claiming all of your exemptions on one W-4 while claiming 0 on the rest will make filing taxes less confusing.
Strategize your W-4 Withholding
Deciding to maximize or minimize your tax withholding isn’t always a simple decision. There are circumstances where it makes more sense to take more allowances and risk owing money at tax time. Others opt to take fewer allowances in order to get a large tax refund at the end of the year.
If you opt to take 0 allowances your employer will take the maximum allowable tax out of your paycheck. This means less money each check, but you could get a large refund at the end of the year. This can also be beneficial if you plan to purchase a home or take out another large loan and want your taxable income to be higher for qualification purposes.
Taking more allowances frees up more cash each check. This can be helpful for people hoping to pay off debt or invest the money elsewhere.
Here’s how I’d make this decision:
- To optimize for every dollar, set your allowances so you barely get a refund on your taxes. You want the refund as low as possible. Instead of giving money to the government for up to a year, keep the cash and invest it earlier.
- To help with saving, pad the refund. Many of us struggle with saving and the refund can help a lot. It’s like getting a bonus of several hundred or thousands of dollars in April each year. Use it to pay off debts, make larger purchases, or invest it as a lump-sum. In this case, claim fewer allowances than you’re entitled to.
- If cash is really tight, get every allowance you can. This puts more money in your pocket every. Just be careful, you don’t want to give yourself a surprise tax bill in April.
Instead of filling out allowances, the W-4 form does allow for one additional option. You can put the exact amount of money you want your employer to withhold from each paycheck. This option can take the guesswork out of whether you’ll owe taxes, get a refund, or break even.
You will need to do a little math to determine your annual income and your tax responsibility if you want to avoid potential penalties.
If you have unearned income or have freelance work, you could authorize your employer to take additional money from each paycheck by putting an amount on Line 6 of the form as well. Many people prefer this option over estimated quarterly tax payments.