When your life situation changes and/or a new year rolls around, it’s a good idea to revisit the amount of money that is being withheld from your paycheck for taxes. This is done by filling out a Form W-4. It’s been a while since I had to complete a W-4 Form for an employer, but I will try to explain how the W-4 Form works and how to determine those crazy allowances.
What is a W-4 Form?
The Form W-4 is simply a form created by the IRS to help your employer collect information needed to take out the proper amount of federal income taxes from your paycheck. What you put on this form will have a direct effect on the amount of money you get in the form of a refund or have to pay to the IRS next year. It doesn’t have an effect on how much you actually pay in taxes for the year. It just affects how much is withheld to be used towards paying your taxes. Make sense?
The Form W-4 and instructions can be downloaded here: Form W-4
The form uses a series of questions to determine the amount of allowances you have. Important: allowances have nothing to do with exemptions. “Allowance” is just another semi-confusing term the IRS came up with to mean “a reason to take less from your paycheck for taxes”. Therefore, the more allowances you claim, the less you employer will tax from your paycheck. Like I said above, this is all reconciled at the end of the year, when you file your tax return and calculate the difference between your withholding and your actual taxes due.
Who is Exempt from Withholding
If you write “exempt” on your W-4, you are telling your employer that you do not want any money withheld from your paycheck for federal taxes. You must meet the following two criteria to file exempt: (1) you were refunded all of your withholding in the previous year because you had no tax liability; (2) you expect to have no tax liability in the current year. If you were claimed as a dependent by someone else, then you might be able to file exempt. You just need to follow this flow chart to determine you ability to file exempt:
How to Fill Out the W-4 Form Allowances
Unless you give the IRS a reason to take less from your paycheck, they will take the amount they feel is necessary based on your income and your marital status. This is where the allowance come into play. Allowances can be made for:
- your spouse
- your dependent(s)
- your child care expenses
- your expected child tax credits
- your itemized deductions (use worksheet on back)
The more allowance you put down, the less they will take out in withholding. Knowing this, people usually take one of two difference approaches:
1. One or Zero Allowances – These people want the maximum taken out of their paycheck. They aren’t worried about giving the government an interest-free loan for a year. They just want a forced savings account and a big refund at the end of the year. If this is you, then regardless of what the true answers to the allowance questions are on the W-4, just make sure that the total (the amount on Line H) is one or zero.
2. The Correct Number of Allowances – Some people choose to aim for zero difference between the amount they have withheld and the amount that have to actually pay in taxes. These people will answer the W-4 Form allowance questions honestly and precisely how their situation dictates. If this is you, then you just need to walk through each of the questions in detail and even consider the additional worksheets on the back for itemized deductions and two-income earners. You will also need to complete a W-4 Form each time your situation changes, not just once a year.
A third approach to avoid would be claiming a bunch of allowances that aren’t true. You will end up owing a lot of money come tax filing time and you will potentially face penalties for underpaying. You don’t want to do that.
I’ve always been a big fan of the second approach. But that’s just me. I’m a tax nerd. If you have any specific questions about the allowances, use my contact form to ask. I’ve run into trouble in the past when I first joined the ranks of the two-income earners. See how I resolved that situation.
Here’s more from the IRS about withholding federal income taxes:
When was the last time you completed a W-4? What changes did you make?