Taking the Mystery Out of the W-4
Have you ever had to fill out a W-4 form and felt like you were in high school again trying to guess the answer to a question you just didn’t understand? After you stare at all of the words and blanks wondering what it all means, you go ahead a put down a number and move on and hope that you chose the right number. While at first glance this form may appear to have more in common with a lottery pick, the reality is that this form can be a tremendous tax planning tool.
The purpose of the W-4 is to provide information to your employer to help determine the required withholding amounts for Federal purposes. It can be a tricky balancing act depending on your situation. If you withhold too much you run the risk of paying too much in each paycheck and then having to wait until you get your refund to get your money back. If you withhold too little you run the risk of not paying enough and having to pay penalty, interest, and a tax bill that you may not have money for.
The real benefit of properly using the W-4 is that it allows your tax payments to be more evenly spread throughout the year. This means if you usually get a large refund you can reduce your withholding rate to give you more disposable money each paycheck where you may need it more. Alternatively, if you find yourself writing large checks each year for taxes you may be able to spread this burden more uniformly throughout the year.
One of the biggest mistakes you can make is to fill out the W-4 once and think that you must live with that for the whole year. You can and should make changes as you have significant tax changes in your life such as the birth of child, child moves out, etc.
So how does the calculation work? Withholding amounts are figured based on marital status and personal allowances. If you select “Single” rate you would have a higher withholding rate than if you selected the “married” rate. Personal allowances take into consideration credits and deductions allowed due to household dependents. The higher the number of personal allowances, the lower the amount withheld and the larger net amount from each paycheck.
For a single taxpayer with one job and no children, the calculation would be very straightforward. However, the majority of people don’t necessarily fit into this narrow bucket. What if both you and your spouse are working? What if you work more than one job? What if you run a business on the side? The W-4 instructions don’t necessarily help when these complications are present.
The good news is that we have tools that can help figure out these complicated situations. So, if you find yourself either getting large refunds, having to write large checks for taxes, or if you simply want to review your options don’t hesitate to give us a call.
Sam Clegg CPA