Starting a new job is exciting until someone hands you a pile of new hire paperwork to complete. Included in that stack will be a federal Form W-4. To understand more about the W-4, irs.gov seems like a reasonable place to start. The IRS describes the form as follows:
Complete Form W-4 so that your employer can withhold the correct federal income tax from your pay. Consider completing a new Form W-4 each year and when your personal or financial situation changes.
“Correct” Withholding
According to the IRS, all taxpayers must do is complete the form and then their employer will withhold the correct amount of federal income tax. One could argue that the “correct” federal income tax withholding would be zero refund or zero remaining tax liability after withholding. But, the reality is that taxpayers are often surprised by their refund or remaining taxes owed when it is time to file their return. The term “correct” is subjective. Some taxpayers prefer a small tax liability or low refund. Others enjoy the satisfaction of a large refund check. With that said, taxpayers should try to reduce or avoid unnecessary underpayment penalties for not withholding enough federal income tax.
Underpayment penalties should not apply if:
- You owe less than $1,000
- Throughout the year, you pay 90% of the tax owed or 100% of the tax on the prior-year return, whichever is smaller
- Taxpayers with adjusted gross income over $150,000 ($75,000 for single taxpayers) will need to pay 90% of what they owe or 110% of the tax on the prior-year return, whichever is smaller
Completing the W-4
The IRS has developed a tool called the “Tax Withholding Estimator,” which was designed to help taxpayers decide if they should make a change to their withholding. This online application guides users in a step-by-step process that gathers the necessary information from the user and suggests an estimated tax liability or refund. The user can select a desired refund to aim for a withholding amount that accommodates their individual preference. Once the user makes this selection, they will receive step-by-step instructions on how to update their W-4 to achieve the desired result. Therefore, taxpayers who use the “Tax Withholding Estimator” do not need to further understand the W-4.
It is important to understand that changing your W-4 will add or subtract from your take-home pay. For example, let’s say you use this tool and compute a net projected tax liability of $6,000 in June 2022. With six months left in the year, you will need to add $1,000 of withholding per month, thereby reducing your take-home pay by the same amount. If the same person waited until October to run the same projection, they would have less time to add to withholding, which would cause more of a financial burden to their family. Using the "Tax Withholding Estimator" earlier and more often allows your family to spread out the positive or negative consequences of making any necessary adjustments.
Also, keep in mind that a W-4 change made in tax year 2022 will carry over to tax year 2023. Take, for instance, the taxpayer in the previous example who was projecting a $6,000 withholding deficiency as of June 2022. Assuming they are in a similar financial situation in 2023, they will likely want to reduce the $1,000 additional withholding because they are no longer trying to catch up on what they underpaid during the first part of 2022.
When might it be a good idea to check in on your withholding status with the “Tax Withholding Estimator”?
- Two or more jobs individually or as a married couple
- Increase or decrease of any source of income
- Marriage or divorce
- Addition or subtraction of dependents
- Large tax refund or large tax liability for the previous tax year
- Claim credits such as the child tax credit (credit likely reduced in 2022)
The IRS redesigned the W-4 in 2020. The redesign is intended to reduce the form’s complexity and increase the accuracy of the withholding system. The new form no longer uses allowances to compute the withholding. Employees should now enter how many dependents they intend to claim to reduce the withholding. There also are other questions and opportunities to provide more detail if necessary. Because employers were not required to ask employees to update their W-4s when the new forms were released, it may be a good time to check up on your withholding status in case you would benefit from an update.
Note: The “Tax Withholding Estimator” tool is not designed to support taxpayers with alternative minimum tax, significant investment income, or other complex tax situations. These taxpayers should contact their tax professional.
If you have any questions or need assistance, please reach out to a professional at FORVIS or submit the Contact Us form below.