Most of us don’t think much about our tax withholding until tax time. That’s when reality sets in — in the form of a big tax bill or a tax refund.
When you file your tax return, you discover whether more than enough money is being withheld from your paychecks for taxes — which spells a tax refund — or not enough money is being withheld, which means you have a tax bill to pay.
If you end up owing a lot or getting a bigger-than-expected tax refund, then the withholding information you provided to your employer on Form W-4 may need adjusting. The goal of adjusting your tax withholding is to have just the correct amount withheld — as close as possible to your actual tax liability.
You can submit a new form W-4 to your employer at any time during the year.
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How tax withholding works
The IRS requires employers to withhold a portion of each employee’s paycheck for federal taxes throughout the year. This built-in mechanism makes it easier for people to keep on top of their tax payments throughout the year.
In the U.S.’s pay-as-you-go system, taxpayers are required to pay taxes as they earn the money, rather than in one big bill at tax time. (This is also why self-employed people must pay estimated taxes four times a year.) Failing to pay taxes throughout the year can lead to an underpayment penalty at tax time.
You need to fill out Form W-4 to instruct your employer how much to withhold from your paychecks for federal income tax. If less than the correct amount is withheld, you’ll owe money (and maybe an underpayment penalty) when filing your tax return, and if too much money is withheld, you will usually get a refund.
The IRS has a tax withholding estimator designed to help you make an accurate estimate of the amount of federal income tax your employer should withhold from your paycheck. The tool will also show you how your take-home pay is affected by your withholding amount, along with the amount of your potential tax refund or tax bill.
To use the IRS tool, you’ll need information about your own paycheck, as well as information about your spouse’s income (both employee income and self-employment income, if applicable), and any other sources of income you may have. There’s no threat to privacy when using the tool since you don’t have to disclose any personal information, such as your name, Social Security number or bank account numbers, and the IRS doesn’t retain any information you enter.
The current version of the W-4 is is based on your filing status and the standard deduction for the year. If you itemize deductions, Form W-4 accounts for that, as well as the number of dependents, household income, tax deductions and tax credits. It may be helpful to have your most recent tax return on hand when completing Form W-4.
When you should adjust your tax withholding
There are a few circumstances that call for adjusting your tax withholding:
- Starting a new job. When starting a new job, your employer will require you to fill out a new Form W-4.
- Getting a big tax refund or owing a big tax bill at tax time. Adjusting your withholding can help you avoid a shock when you file your taxes.
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Experiencing a major life change, such as:
- Getting married or divorced.
- Having or adopting a child.
- Your child turning 17 (at which point they no longer qualify for the child tax credit).
- Buying a home.
- A large drop in income, or losing your job.
- You or your spouse takes on part-time work or a second job.
- Paying off student loans.
- Contributing substantially more or less to a tax-deferred retirement plan.
How to adjust your tax withholding
The degree of complexity in filling out your W-4 varies a lot based on your situation.
Simple W-4 situations
- If you’re single with just one job, no dependents and you take the standard deduction, then the form is easy to complete. You just have to fill out the top part (Step 1) with your name, address, Social Security number and tax filing status. Then skip Steps 2 to 4, and provide your signature and date on the bottom of the form (Step 5).
- If you’re married and both you and your spouse are employed and make about the same amount of money, you might be able to get away with doing the same as above, plus checking the box in Step 2(c). Each spouse would have to do this on their respective Form W-4. If one spouse earns considerably more money than the other, then too much tax may be withheld (that means less money in your paychecks and a bigger refund at tax time).
More complex W-4 situations
If you, or your spouse if married, earn income from several sources or have dependents, it gets more complicated.
For Step 2 on Form W-4, you must choose one of three ways to account for your various income sources:
- Use the IRS tax withholding tool for the best results;
- Fill out the Multiple Jobs Worksheet on page 3 of the form (this worksheet is for your records; you don’t submit it to your employer); or
- Take the shortcut described earlier for two-income households with similar pay.
In Step 3, you enter information regarding tax credits, including the child tax credit and the credit for other dependents.
You can also factor in other tax credits you qualify for, such as the American Opportunity Tax Credit and Lifetime Learning Credit for college costs, and the foreign tax credit, if you like. Keep in mind that adding information about credits in Step 3 will mean more money in your paychecks — but a smaller tax refund at tax time. (That is, you will have less withheld because these tax credits will reduce your overall tax bill.)
Step 4(a) is where you can add unearned income, such as from interest, dividends and Social Security.
Step 4(b) is to note any deductions you might take — other than the standard deduction. There’s a deductions worksheet for Step 4(b) that factors in itemized deductions, including mortgage interest, charitable contributions, medical expenses and state and local taxes. This worksheet is for your records, and isn’t submitted to your employer.
If you generally claim the standard deduction — which a majority of taxpayers do — then you can use Step 4(b) to add so-called “above the line” deductions (deductions you can claim even if you don’t itemize), such as student loan interest and deductible IRA contributions. However, don’t add the actual standard deduction amount to the total as this will result in an error.
Step 4(c) is for adding any additional amount you want withheld from each paycheck. Dollar amounts that you enter here will reduce your paycheck and either reduce the amount you owe at tax time or increase your tax refund.
Keep in mind:
If you have another job and you don’t want to share this fact with your employer, you can use the IRS tax withholding estimator to calculate your projected tax liability and then put an “extra withholding” amount in Step 4(c). This won’t raise suspicions since, as far as your boss is concerned, you might want to do that anyway simply to get a bigger tax refund.
Claiming exempt status
If you didn’t owe tax last year and won’t owe tax this year because you expect to earn less than the standard deduction amount for your filing status, then you can simply fill out the top part of the form, write “exempt” in the space below line 4(c), and sign and date the form.
If you claim the exemption, no income tax is withheld from your paycheck. Keep in mind, though, that if you do owe taxes, you may face penalties when filing your tax return. This exercise will need to be repeated each year, as the exemption status is good for one year only, and you will need to submit a new Form W-4 by mid-February.
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