Get Your Tax Withholding Just Right (Form W-4)
How to Tell If Your Withholding Is Wrong—and What to Do About It
Form W-4 provides your employer with the information it needs to calculate how much in the way of Social Security, Medicare and income taxes it should withhold from each paycheck to send to the IRS on your behalf.
The goal is to get your W-4 withholding allowances just right so that your employer holds back the same exact amount that you’ll owe in taxes at the end of the year, but this can be a somewhat complicated process.
Income Tax Withholding
Several factors influence the amount of income tax withheld from your pay, including your filing status and how many dependents you have. Your employer will apply the information you’ve entered on your W-4 to the Income Tax Withholding Table published by the Internal Revenue Service to determine what percentage of your pay must go to income taxes.
Your employer will withhold more to cover your income tax bill if you’re single with no dependents than if you’re married or single but with one or more dependents. This happens because you and your dependents each represent an “allowance” on your W-4. The more allowances you have, the less tax you pay and the more money you get on your check to cover monthly expenses.
How to Determine Your Allowances
Normally, as shown on the worksheet attached to the W-4 form, you would enter two allowances on your W-4 if you’re single with no dependents and have only one source of income. This means one allowance for yourself, and one allowance because you’re single and working just one job.
It gets more complicated if you work multiple jobs, if you’re married, or if you’re single but have dependents—because you might qualify for head of household filing status. Another wrinkle comes up if you only work for part of the year.
Fear not though, because the IRS stands by ready to help. The W-4 worksheet has everything you need to calculate the correct number of allowances you should claim.
The IRS also offers an interactive withholding calculator online. This calculator automatically makes adjustments if it appears that you might be eligible for any tax credits that will affect your end-of-year tax liability. It also accommodates more than one income if you’re married and planning to file a joint return.
Should You Ever Claim Fewer Allowances?
You don’t have to claim allowances if you don’t want to. For example, you might do a little freelance work on the side apart from your regular job for which you’ll receive a 1099-MISC form at the end of the year. Taxes aren't withheld from this type of income.
The IRS prefers to be paid when you get paid so you can either send in quarterly estimated tax payments to cover this 1099 income using Form 1040-ES, or you can claim zero allowances on your W-4 form so more money than necessary comes out of your paychecks from your primary job and goes to the IRS to cover the taxes owed on your 1099 income.
If you’re not receiving other income that you want to cover the taxes on, claiming a lower withholding allowance only results in you using the IRS as a savings account (that pays no interest) so you'll probably want to claim each allowance for which you're entitled.
FICA Tax Withholding
Your employer will also withhold additional money to cover your FICA taxes. FICA stands for the Federal Insurance Contributions Act and it covers Social Security and Medicare taxes, both of which are essentially insurance funds for the benefit of the disabled and elderly. They’re obligatory. You don’t have the option of not paying them, and the amount of your future social security benefits depends on them.
The Social Security tax amounts to 6.2 percent of your gross income as of 2018. Medicare is 1.45 percent, although you may be subject to the Additional Medicare Tax if your income exceeds certain limits: $200,000 if you're single or file as head of household, $250,000 if you're married filing jointly, and $125,000 if you're married but file a separate return.
These percentages are withheld from your paychecks and your employer must contribute equal amounts. You don’t have any wiggle room to adjust the amounts because they're fixed rates.
Be Alert With Social Security Withholdings
It’s possible to pay too much in Social Security tax, however, so this withholding is something you’ll want to keep an eye on as the year progresses. if you earn more than $128,400
The Social Security tax is subject to a wage base limit. This means that when your earnings hit a certain threshold, you no longer have to pay Social Security tax—for that tax year anyway. Withholding begins again the following January.
The earnings threshold is $128,400 as of 2018. You don't have to pay Social Security tax on income over this amount. When and if you hit this earnings level, touch base with your employer to make sure the company realizes that you no longer have to contribute to Social Security until the next tax year. This is particularly the case if you work more than one job and have one or more employers withholding Social Security tax from your pay.
Are You Exempt From Withholding?
A few individuals are exempt from tax withholding and Form W-4 provides a box that these taxpayers can use to indicate this. Just write "exempt" in box 7 and complete boxes 1, 2, 3, and 4.
You're generally exempt if you had absolutely no tax liability last year and you expect to have none this year. This means you received a refund for every dime that was withheld from your pay last year and circumstances haven't changed so the situation will repeat itself this year. But you might want to check with a tax professional first to make absolutely sure you meet these qualifications.
You'll have to redo your W-4 to indicate this each year that you qualify. For example, an exemption for 2018 lapses or expires as of Feb. 15, 2019.
That’s It. You’re Done. Or Are You?
Completing your Form W-4 isn’t a one-time event. Life isn’t stagnant and certain changes can make the form out-of-date in a flash, resulting in withholdings that are too much or too little. Use the IRS interactive calculator to rework your withholding allowances if you get married, get divorced, or have a child. You might also want to recalculate if you get a raise, buy a home, or make any new investments.
Ask your employer for a new W-4 and complete it to reflect the new information if any of these things happen. You can complete a new W-4 anytime you'd like and give it to your employer. It doesn’t have to be filed with the IRS. Any changes should show up in your take-home pay pretty much immediately.
You can also adjust your W-4 at any time simply because you got it wrong last year. You don’t have to wait for a new tax year to roll around. Make adjustments as soon as possible.
The Effect of the New Tax Law
You don't necessarily have to worry if you noticed a difference in your take-home pay earlier in 2018...even though you didn't make any changes to your W-4. The IRS issued new withholding guidelines to employers in February to reflect the changes made by the Tax Cuts and Jobs Act that went into effect in January.
The new tax law changed tax brackets and the standard deductions for each filing status and this is probably reflected in your paychecks. You might want to review your allowances, however, just to make sure you're still covered without over-withholding and using the IRS as an interest-free savings account.
You Know You Got It Wrong If…
How much of a refund did you get last year? Did you owe the IRS money instead? These are both clues that you didn’t get your withholding allowances right when you completed your W-4, particularly if your refund or your deficit was significant.
If you received a nice, walloping tax refund, you gave the IRS way more money than you had to. Unless you qualified for a refundable tax credit or two and that represents part of your refund, this is just your own money being returned to you interest-free after the close of the tax year. It didn’t grow for you as it would have if you had given the IRS just enough over the course of the year and placed the excess in a savings account or investment instead.
If you complete your tax return only to realize that you owe the IRS money, this is even worse. Not only will you have to come up with that money long after you earned it, but the IRS may impose an underpayment penalty on top of it.
The penalty kicks in if you paid in less than 90 percent of what you owe or less than what you paid last year, whichever is less. You’ll dodge the penalty bullet if the total of what you owe is less than $1,000 after calculating in what you paid through withholding and any refundable credits you’re entitled to.
An Easy, Temporary Fix
If you complete your tax return by April and realize you owe money, and if nothing in your life has changed that would require completing a new W-4, you can divide how much you ended up owing by the number of pay periods remaining in the year.
Let’s say you owe $3,000 and you’re paid weekly and there are 36 weeks left in the tax year. Based on your current W-4, which assumes your pay stays the same as last year, you’ll be running at about an $83 deficit for tax withholdings on each paycheck during that time period. If you ask your employer to withhold an additional $83 from each of your paychecks going forward through the remainder of the year, you shouldn’t owe money again come next April.
You can take the same precaution if you suddenly come into extra money. Ask your employer to withhold a little extra to accommodate that additional income. Otherwise, if you have the available cash, you can make an immediate estimated tax payment to the IRS using Form 1040-ES and leave your employer out of it.
If your extra money is due to a pay increase, however, this option should only be used as a Band-Aid. It’s a quick fix, a temporary remedy until you get your W-4 completed correctly, and you’ll want to do this as soon as possible.