Unexpected tax bills can quickly throw a household into chaos, but experts say one simple tax form is often the cause of the surprise — and the penalties, interest, tax liens or other financial drama that often ensue.
That form is the short, innocent-looking W-4. Essentially, it lets employees tell employers how much tax to withhold from their paychecks. Employers remit that tax to the IRS on the employees’ behalf throughout the year. During tax season, when it’s time to calculate Uncle Sam’s cut of your income for the past year, the money already withheld from your pay is supposed to cover the bill. But sometimes it doesn’t.
Many people don’t understand how much power the W-4 wields, says Naomi Ganoe, a CPA and managing director at accounting services firm CBIZ MHM in Akron, Ohio. It’s a common oversight — after all, the W-4 is typically buried in a stack of paperwork that employees fill out on the first day of a new job.
“You fill it out, and you don’t really think much about it after that,” she says.
More means less, less means more
But people often don’t realize that what they put on the W-4 directly affects their take-home pay, and by extension much of their day-to-day financial lives, Ganoe warns. The more allowances an employee claims on a W-4, the less tax the employer withholds from that person’s paycheck, which leaves more to bring home on payday. Likewise, fewer allowances on the W-4 translate to more tax withheld (and less take-home pay). In 2019, each withholding allowance represents $4,200 of income that should not be taxed.
The good news is that you can change your W-4 any time, and you can even instruct an employer to withhold a flat dollar amount, which provides some control, says Ann Kish, an enrolled agent and senior manager at accounting firm Brink, Key & Chludzinski in Portage, Michigan. Blank W-4 forms are available at IRS.gov and usually from company payroll departments.
Updating your W-4 is especially important if you’ve gotten married or divorced, bought a house, paid off a mortgage, or had a child — all of which can significantly change your tax obligations, Ganoe adds. That’s one reason projecting your tax liability for the year is an important step in figuring out how much to withhold, she says. The IRS’s withholding calculator can help. Tax preparers and your tax-prep software often can provide guidance as well.
Find the right balance
If you’re thinking of having more tax withheld from your pay in order to avoid a surprise tax bill next year, be sure not to go overboard. Withholding too much tax can generate a big tax refund in April. That may sound nice, but it means living on less of your paycheck all year.
“Reducing the withholding now can really help you in your budget, as opposed to getting this large refund when you file your tax return in March or April,” Ganoe notes.
Getting a $3,000 refund (about average, according to the IRS) in April, for example, means giving up $250 every month — money that might have helped fill cupboards, pay for doctor visits or car repairs, prevent overdue bills or avoid running up credit card debt during the year.
“The goal is to reduce your potential for both your tax bill and your tax refund to zero — or as close to zero as you can get,” Kish says.
That might be easier said than done, though. Many people are trying to find the right balance — especially this tax season, Ganoe says, when several new tax rules have taken effect.
“I’ve had so many conversations on W-4 this year, more so than I probably had my entire career as a CPA,” she says.