Tax reform happened. Now what?
Dec. 20, 2017, update: Congress passed a tax reform bill that includes revised federal income tax brackets and the removal of the personal exemption. The rules generally take effect on Jan. 1, 2018, which means the formulas used to calculate withholding for payroll taxes likely will change in a few weeks. Your paycheck might change as a result. The Form W-4 lets you have some control over those withholdings.
The W-4 is a deceptively simple tax form you fill out when you start a new job. It’s tempting to speed through this little half-page document, but if you don’t take a minute and think about how to fill it out, you could unnecessarily shrink your paycheck or get hit with a surprise tax bill in April.
Why you have to fill out a W-4
Income tax is a pay-as-you-earn affair — the minute you get paid, the IRS wants its cut. That’s why the W-4 exists: It’s a form that instructs your employer how much tax to withhold from each paycheck. Your employer remits that amount to the IRS on your behalf, and at the end of the year, your employer will send you a W-2 showing (among other things) how much it withheld for you that year.
How do I fill out my W-4?
The W-4 form asks for your name, address, marital status and other basic personal information. You’ll fill these out and sign at the end. That’s the easy part. The hard part is deciding the number of allowances you want to claim — which is really deciding how much of your paycheck you want set aside automatically for taxes.
Here’s the rule of thumb: The more allowances you claim, the less money will be taken out of your pay to go toward taxes.
Here’s the general strategy: If you got a huge tax bill in April and don’t want another, reduce the number of allowances you claim to have your employer withhold more tax from your paychecks so that you owe less (or nothing) next April. If you got a huge refund last year and would rather not have that money withheld throughout the year, do the opposite and reduce your withholding. A big refund might be “forced savings,” but you’re also giving the government a free loan and could be needlessly living on less of your paycheck all year.
Let’s get into specifics. The W-4’s goal is to determine two things:
Are you exempt from withholding?
Being exempt means your employer won’t withhold any federal income tax from your pay. (Social Security and Medicare taxes will still come out of your check, though.)
Generally, the only way you can claim exemption from withholding is if two things are true:
- You got a refund of all your federal income tax withheld last year because you had no tax liability, and
- You expect the same thing to happen this year
How much do you want the IRS to take out of your check?
If you’re not exempt from withholding, you need to decide how much tax you want your employer to take out of your pay. Again, the name of the game is to get the right amount withheld throughout the year so you don’t have a surprise — refund or bill — in April.
Generally, the more withholding allowances you claim — and we’ll define these in a moment — the less income tax will be withheld from your paycheck. The exact amount depends on how much you earn and the information you put on your W-4.
Three things go into the mix:
- Whether you’re single or married
- How many withholding allowances you claim
- Whether you want any extra money withheld
Indicating whether you’re single or married is pretty straightforward, but claiming allowances isn’t as easy. Follow the instructions on Form W-4 to calculate the number of withholding allowances to claim. It has worksheets (see the examples below) to help you think through the decision.
Here are some examples of things that get you an allowance — that is, they decrease the amount of tax withheld from your paycheck:
- Having a spouse
- Having kids
- Filing as head of household on your tax return (go here to see if you can do that)
- Planning to take the Child and Dependent Care Credit
- Planning to take the Child Tax Credit (go here to see if you qualify for these credits)
How to make sure your W-4 doesn’t sting you in April
It’s easy to just throw a couple of numbers onto your W-4 and be done with it, but rushing might come back to bite you later. Here are a few things to remember.
Don’t run up your allowances
It might be tempting to claim a ton of allowances so you can keep more of your pay, but that’s usually a bad idea, says Shawn Hermanson, a certified public accountant in Coon Rapids, Minnesota.
“We’ll have people that will go in that are single and unmarried and what they’ll do is they’ll list eight or nine exemptions and have little to no withholding taken out of each paycheck,” he says. “That’s a big problem. Unless you’ve got a mountain of deductions or losses to help offset that income, you’re going to end up with a nasty surprise on April 15.”
File a new W-4 at work when life changes
If any of these events happen to you during the year, update your W-4 so your withholdings reflect your new tax situation:
- You get married or divorced
- You have a kid
- You buy a house
- You take a pay cut or receive a big raise
- You work only part of the year
- You have a lot of dividend income
- You or your spouse freelance on the side
You’ll receive a W-4 when you start a job, but you can change your W-4 any time. Just download it from the IRS website, fill it out and give it to your human resources or payroll team. The IRS requires employers to put your new W-4 into effect by the start of the first payroll period ending 30 or more days after you turn it in.
Be willing to fiddle with your withholdings
Tinkering is OK, says Dave Danic, tax manager at Summit CPA Group in Fort Wayne, Indiana.
“Here’s what you do. If you come up with a 2 [for allowances] and you want a bigger refund, then I would say let’s lower it down to 1. Then, check your next paycheck to see how much more money was withheld. Then you can start annualizing what your withholdings are going to be at the end of the year,” he said.
If you want to withhold more money from each paycheck, enter a dollar amount on line No. 6 of the W-4 form.
The IRS’ W-4 calculator can help you decide how many allowances to claim based on the amount you’ve withheld so far and your filing status. And if that means spending more than 30 seconds on all this, don’t be ashamed — at least you won’t be suffering any consequences in April.