The W-4 form is short and might seem easy to fill out, yet it still confuses many people. It is particularly confounding to know how many allowances to claim on the W-4.
Let's take a look at the W-4 form, define and discuss some W-4 allowances, and cover some smart strategies you might employ.
What's a W-4?
A W-4 is a form from the IRS that your employer will require you to fill out so that it will know how much money to withhold from your paychecks for taxes. That's because most of us don't just pay our taxes in April, but throughout the year, either when employers withhold and submit tax dollars on our behalf to the IRS or when self-employed folks pay quarterly estimated taxes. It might seem like a pain, but having most of your tax obligation automatically withheld before it ever reaches your hand is probably less painful than having to cough up many thousands of dollars on demand in April.
Thus, the W-4 form is necessary. It takes up four pages, but the part your employer requires is only the bottom third of the first page. There is also a personal allowances worksheet, a worksheet for people who itemize deductions or have other unique circumstances, and a worksheet for dual-earning married couples or folks that have multiple jobs.
The part of the form that you must fill out and submit asks for:
- Your name and address
- Your Social Security number
- Whether you're single or married (and, if married, if you'd like your withholding done at the higher rate for single folks)
- The total number of allowances you are claiming on the W-4
- Any additional amount you'd like withheld from each pay period
- Whether you're exempt, having had no tax liability last year and having received a refund of taxes withheld, and expecting the same this year
- Your signature
That should all seem pretty straightforward, except for the allowances.
By far, the most common question I hear is about the term tax allowance. When you hear “tax allowance,” think “tax break.” Each allowance you claim will reduce the amount withheld from your paychecks.
The Personal Allowances Worksheet will help you arrive at the right number. You claim one allowance for yourself if you're being claimed as a dependent on anyone else's tax return. You then add more allowances as you go down a list of conditions.
For example, if you're single with only one job, or married with a non-working spouse, you add another allowance. If you file your tax return as a Head of Household, you add another. You'll end up with a number that you can record on the form (on Line 5) as the number of allowances you're claiming.
It's not always quite that simple, though. If you plan to itemize or claim adjustments to income, you might want to reduce your withholding. You might also need to increase your withholding if you receive substantial income from interest, dividends, investment sales, annuities, or rentals. You can use the “Deductions, Adjustments, and Additional Income Worksheet” to help you figure out how many allowances to claim.
If you're single and work two or more jobs or are married with both spouses working, and your total earnings from all jobs exceeds $53,000 if you're single or $24,450 if you're married, you'll want to check out the last page of the W-4 and complete the "Two-Earners/Multiple Jobs Worksheet," lest you end up having too little tax withheld.
If you find the form and its worksheets intimidating, the IRS makes the calculations simpler with its Withholding Calculator -- give it a whirl. If you use tax-prep software, it might also offer a withholding-determining calculator.
When the W-4 form is especially important
The W-4 form needs particular attention at certain times in your life. Obviously, every time you start a new job, you should file one with your employer. Less obviously, though, you should also file one when your financial life changes in a significant way, such as when you get married or divorced, gain or lose a dependent, lose a job, retire, buy or sell a home, realize significant capital gains from the sale of investments, inherit a lot of money, declare bankruptcy, cash in stock options, or have dependent-care costs that change a lot.
You can choose to update the form at any time -- a particular triggering event is not required. Note that if you don't file a W4 form with your employer, then your employer is required to withhold taxes at the highest rate -- as if you're a single person with no allowances claimed.
The most logical approach to determining how many allowances to claim is to get as close as possible to having your total tax due for the year automatically withheld. Having too much withheld and then getting a hefty refund is exciting, but it really means you lent money to Uncle Sam interest-free during the year. Having too little withheld will mean you'll have to come up with whatever is due, which isn't always easy. In addition, if you underpay your taxes too much, you may have to pay a penalty charge and possibly interest, too. What's too much? Generally, you don't want to owe more than $1,000 beyond your withheld amount -- or to have paid less than 90% of the total tax due for the current year or less than 100% of your prior-year tax, whichever is the smaller amount.
In summary, the W-4 is your best shot at estimating how much tax you will owe so that your employer can withhold the right amount. If you spend a little more time on completing this form accurately, you’ll thank yourself come tax time in April.