W-4 Basics: Understanding Tax Withholding
Tax season is here again! As the April 15th tax deadline approaches, there's a noticeable increase in inquiries concerning federal and state income tax withholding. Frequently, employees express concern about insufficient tax deductions, leading to unexpected tax liabilities. Below, we will break down the basics of withholding tax and explain why paychecks might not always perfectly align with the finalized tax return.
What is Tax Withholding?
In simple terms, tax withholding is an advance payment of income tax liability. These payments are taken out of each paycheck throughout the year rather than paid as a lump sum during tax season. This tax structure aims to help taxpayers avoid a large tax bill at the end of the year and ensure the government receives tax revenue regularly.
How to accurately fill out your W-4: The Tax Foundation
The foundation of accurate withholding is the IRS Form W-4, "Employee's Withholding Certificate." This form is essential for determining the amount of federal income tax that will be withheld from your employees’ paychecks.
It is important to note that employers cannot complete W-4 forms for employees, nor should they offer advice on completion. It is recommended that employees submit the full four-page form, as it includes a worksheet designed to help them determine the appropriate entries. Additionally, employees can use the IRS Tax Withholding Estimator, which can be accessed via the URL printed on the first page of the W-4. Employees only need to submit the first page to their employer. The most current federal form can be found at IRS.gov.
While employers are not able to provide personalized advice, general guidance is allowed to be provided:
Filing Status: Single or Married Filing Separately generally results in higher withholding. Married Filing Jointly leads to lower withholding. Head of Household typically results in the lowest withholding, but it has specific eligibility requirements.
Dependents: Claiming dependents usually reduces the amount of tax withheld.
Important notes for employers:
Employers must retain employee W-4 forms on file for at least four years and make them available to the IRS upon request.
If an employee fails to complete a W-4, the employer is legally obligated to withhold taxes as if the employee is Single/Married Filing Separately with no dependents.
The Limitations of Payroll Systems
Here's a crucial point: a paycheck reflects only a portion of your overall tax picture. An employer and payroll provider can only calculate withholding based on:
Your taxable wages for the pay period.
The frequency of payment.
The information you provide on your W-4.
Only employees themselves have access to information regarding income sources, deductions, or credits. Individual tax returns consider all these factors, which is why the amount withheld from each paycheck might not perfectly match the final tax liability.
Common Withholding Pitfalls
These are the most common mistakes leading to under-withholding on taxes:
Double-Claiming Dependents: When both spouses claim the same dependents on their W-4s, it reduces withholding excessively.
Incorrect Filing Status: Single taxpayers claim Head of Household without meeting the eligibility criteria.
Multiple Jobs: Employees with multiple jobs may be under-withheld because each employer only considers the income earned from that specific job, applying a lower tax bracket than the employee should be in.
Life Changes: Failing to update the W-4 after significant life events can lead to inaccurate withholding. These events include, but are not limited to:
Marriage or divorce
Death of a spouse or dependent
Birth or adoption of a child
Changes in retirement contributions
Buying or selling a home
Significant non-wage income such as freelance work, rental income, or inheritances
State Withholding Taxes
Many states use their own version of the W-4. The tax basis for the states may be significantly different from federal. Encourage usage of the state withholding form by providing it to employees. If you’re not sure where to find the form for your state, please consult with your Account Representative.
Take Control of Your Tax Withholding
The key takeaway is that your employees are responsible for ensuring the W-4 accurately reflects their financial situation. Employees should regularly review their withholding, especially after any major life changes. Utilizing the IRS Tax Withholding Estimator is a great way to verify that the withholding is on track.
By understanding the basics of withholding and taking proactive steps, employees can minimize surprises come time to finalize taxes each year.
PayWorks is not providing legal or tax advice. The information on this website is for informational purposes only and should not be relied upon as legal or tax advice. You should consult with your own legal and tax advisors before making any decisions about your financial situation.