How to Fill Out a W-4—Plus, 7 Reasons to Adjust Your Tax Withholding
Confused about how to fill out a W-4 at work? Laura explains what it is and how to complete it correctly. Plus, you’ll learn 7 reasons when you should adjust your withholding so your employer doesn’t take out the wrong amount or leave you with an unexpected tax bill.
As soon as you start a new job, someone from the human resources or payroll department asks you to complete on-boarding forms. One of them is the often-dreaded Form W-4, Employee’s Withholding Allowance Certificateopens PDF file .
Many people get very anxious about filling it out because they don’t understand what an “allowance” is and they worry about what could happen if they make a mistake.
In this post, I’ll take the mystery out of the W-4 by explaining what it is and how to complete it correctly. Plus, I’ll cover 7 reasons you should adjust your withholding so your employer doesn’t take out the wrong amount or leave you with an unexpected tax bill.
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What Is Tax Withholding?
The purpose of completing a W-4 form is to tell your employer how much federal income tax to deduct from your paycheck. And if you live in a state that collects income tax, you’ll also need to fill out a state form. There are just seven states that don’t tax ordinary income: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
Your tax deductions are known as payroll “withholding,” because tax is withheld from you and paid directly to the IRS or the state instead. It’s like a credit against the total amount of tax that you’ll owe for the year.
Your tax deductions are known as payroll “withholding,” because tax is withheld from you and paid directly to the IRS or the state instead. It’s like a credit against the total amount of tax that you’ll owe for the year.
Companies are required to withhold money from your paycheck because income taxes are “pay-as-you-go” taxes. In other words, you must pay them as soon as you earn money during the year. That reduces the likelihood that you could evade paying them.
Employers are required to withhold 4 different types of taxes from your paycheck:
- Federal income taxes
- State income taxes (where applicable)
- Social Security taxes
- Medicare taxes
The amounts you ultimately owe each year for federal and state income tax depend on various factors such as your income, tax filing status (such as single or married filing jointly), and available tax deductions and credits you qualify for and claim.
There are 7 different federal income tax brackets that range from 10% up to 39.6% of income. States have their own tax systems that vary widely. The W-4 and state tax forms help employers estimate what you’ll owe so they can remit it on your behalf.
Estimating your Social Security and Medicare taxes is straightforward because you and your employer must pay set amounts each year. These two taxes are collectively known as FICA, which stands for the Federal Insurance Contributions Act tax.
Most of you probably know that Medicare is the federal program that provides a certain amount of health insurance benefits once you reach age 65. The benefits provided by Social Security are summarized by the program’s official name, OASDI. This acronym stands for old-age, survivors, and disability insurance.
Many people don’t realize that employers pay half the amount of FICA on your behalf. So, in each paycheck you pay just 50% and your employer remits the remaining 50%. The amount of Social Security retirement benefits that you receive is tied to how much you and your various employers have paid into the program over your career.
In 2017, the tax rate for Social Security is 6.2%–up to a wage threshold of $127,200. So, employers withhold 6.2% from each of your paychecks and kick in another 6.2% on your behalf, for a total of 12.4% that goes to the IRS.
The Medicare tax rate is 1.45%, with no wage threshold. So, both you and your employer pay a combined total of 2.9% no matter how much you earn. So, FICA withholding, which is the combined rate for Social Security and Medicare, translates into you paying 7.65% and your employer paying 7.65%, for a grand total of 15.3%.
If you’re self-employed, you pay both the employee and employer side of FICA tax, a bigger tax burden than when you’re an employee. To keep up with the tax, the IRS requires you to estimate your annual taxes and pay one fourth of the amount each quarter.
See also: 5 Ways to Pay a Tax Bill You Can’t Afford
What Is a Form W-4?
The more allowances you claim on a W-4, the less tax your employer must deduct.
Now that you understand all the taxes that get withheld from your paycheck, let’s cover more about how to fill out your W-4 correctly. It’s called an allowance certificate because it adds up your “allowances,” which tells your employer how much to take out of your pay.
The more allowances you claim on a W-4, the less tax your employer must deduct. You get one allowance for yourself, one for a spouse, and one for each dependent you report on your tax return. Having less taken out sounds great—but remember that you’ll owe the difference on Tax Day. And if you don’t pay, the IRS charges penalties and interest, and can even garnish your paycheck to collect it.
On the flip side, when you claim fewer allowances, more tax is taken out of your paycheck throughout the year, giving you less take-home pay. When too much tax is withheld and you overpay for the year, the IRS issues you a tax refund.
See also: 5 Smart Ways to Spend a Tax Refund
While getting a refund might seem like free money, it isn’t. You’re just finally getting back your own money that you paid into the system in the previous year. Getting a tax refund means that you gave the IRS an interest-free loan instead of keeping it for yourself and using it to improve your financial health by saving, investing, and paying down debt throughout the year.
Also consider how you’re likely to use a tax refund windfall. Would you use it more wisely or less wisely than if the money had come to you gradually over the year in each paycheck? You may feel that it’s too tempting to get a big tax refund and not blow it on something frivolous, like a vacation. Or you may feel the opposite, that you could do more financial good with a lump sum windfall.
So, be realistic about how you’ve spent tax refunds in the past. If you’ve used them like a forced savings plan in ways that truly improve your finances, overpaying taxes isn’t the worst financial move you could make.
However, my advice, in general, is to have withholding that matches your actual tax liability as closely as possible. An exception comes into play when you expect a larger than normal tax bill and want additional withholding to cover it.
For instance, if you have self-employment income in addition to your regular W-4 job or you expect a financial windfall during the tax year, you’ll have to pay more tax. By voluntarily increasing the amount of tax deducted from each paycheck, you can avoid having to make a big lump-sum tax payment at the end of the year.
If you don’t complete a W-4 your employer will simply assume that you have zero allowances and deduct the highest amount of tax, which could be way too much
And if you expect to earn very little, you can also indicate on a W-4 that you should be exempt and have no tax withheld from your pay. For instance, if you’re single, under age 65, and earned less than $10,350 in 2016, you don’t have to pay tax.
Employers use tables published by the IRS each year to figure out how much to deduct from your paycheck based on your filing status (such as single or married filing jointly), gross income, and withholding allowances you claim.
If you don’t complete a W-4 your employer will simply assume that you have zero allowances and deduct the highest amount of tax, which could be way too much. So always take charge of your taxes by completing withholding forms the best way you can.
Related: A Checklist to Measure Your Personal Finance Success
7 Reasons to Update Your W-4 Form Tax Withholding
One of the biggest misconceptions about a W-4 or state form is that you can’t change it. The truth is that you can and should submit new withholding forms to your boss or payroll department any time something major changes in your life that affects your tax situation.
So, don’t set and forget your withholding. Some employers may send out an annual reminder about this, but others won’t. So, put a note on your calendar to revisit this at the beginning of each year or at some other anniversary, such as your open enrollment period for insurance benefits.
If nothing has changed, you’re not required to complete a new form each year, unless you’ve claimed that you’re exempt from withholding. Here are 7 key reasons you should update your W-4:
1. Your income increases. Let’s say you get a second full- or part-time job, do freelance work, or start a home business on the side. Your tax liability typically goes up as you earn more. Even if your additional income comes from a side hustle with no W-4, you can adjust the form at your main job to account for it. No explanation to your employer is needed.
2. Your spouse’s income increases. If you’re married, both work, and file taxes jointly, any change in your household income will affect your taxes. So, evaluate your withholding as a couple using your combined income to figure allowances. One spouse could claim all of them, or you can divide them between both of your W-4s. The second page of the W-4 includes a worksheet to help figure allowances when there are two-earners in a household.
3. Your income goes down. If you (or a spouse) lose side income or become unemployed for part of the year, you may have too much tax withheld. Increasing the number of allowances on your current W-4 or when you complete one at your next job in the same year, will reduce your withholding.
4. Your marital status changes. Getting married or divorced radically changes your tax situation. You may also begin receiving alimony, which is taxable income. So be sure to adjust your W-4 as soon as you’re officially hitched or un-hitched. If you wish, you can claim an allowance for a spouse, which as I previously mentioned, reduces your withholding.
5. You become a parent. Having or adopting a child is a major tax event because it qualifies you for new deductions and credits. You can claim an additional allowance for each dependent, reducing your withholding.
6. You qualify for new tax benefits. When you qualify for tax deductions or credits, your tax liability goes down. For instance, if you claim the home mortgage interest deduction, medical expense deductions, or make retirement account contributions, they should be a signal to review your withholding. The second page of the W-4 includes a worksheet to enter deductions and other adjustments into the mix.
7. You got a large tax refund. If you get a refund of more than a few hundred dollars and expect your life and financial situation to be the same in the current tax year, consider increasing your allowances so you have less withheld and get a bigger net paycheck going forward.
See also: How to Pay Less in Taxes (Part 1)
How to Change Your W-4 Tax Withholding
Changing your W-4 is easy to do on paper or electronically. You can print out the fillable formopens PDF file , sign it, and send it to your employer (or agency that handles your payroll). You don’t need to submit it to the IRS. Some payroll systems, like ADP, allow you to complete and sign your W-4 electronically.
If you need help figuring out if you should change a W-4, don’t ask your employer because it’s not their responsibility to guide you. Check out these free resources and tools to help you figure out your ideal number of allowances:
- IRS Withholding Calculator
- TurboTax W-4 Withholding Calculator
- PaycheckCity W-4 Assistant
- IRS Publication 505, Tax Withholding and Estimated Tax.opens PDF file
When you figure your allowances and get a different result than your current withholding, submit a new form to your employer. Just remember that changes aren’t retroactive for the year, they only impact your future paychecks.
If you have a complex financial situation or just aren’t sure how estimate what your total tax liability will be for the year, be sure to speak with a tax accountant before you submit your W-4 or when you’re ready to revise it.
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
