What is a W4?
Generally, when you start a new job your employer gives you a load of paperwork to fill out. Arguably the most important document of the bunch is IRS form W-4. The numbers you enter on this form dictate how much income tax your employer withholds from your paycheck. This impacts whether or not you owe money to the IRS at the end of the year.
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Function
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Most Americans work at a job where they receive a paycheck on a regular basis. Your employer withholds federal income tax from each of these checks and sends it to the IRS. You essentially tell them how much to take out as a result of the information you enter on your W-4 form. The number is derived from a formula that uses your filing status, dependent status, the number of dependents you can claim and your anticipated child tax credit, if any, to determine how much to withhold. On your W-4, you can also instruct your employer to withhold additional money from each paycheck.
Features
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IRS Form W-4 has spaces for you to provide your personal identifying information, such as name, address and Social Security Number, as well as a Personal Allowances Worksheet that tallies up the number you need to include in Line H. If you are unsure how to complete the worksheet, check with your tax advisor or refer to one of the worksheets that are part of the W-4. The IRS provides worksheets and tables that determine your Line H number if you plan on itemizing deductions, if you are part of a household with two wage earners or if you have multiple jobs.
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Considerations
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Generally, the larger the number that ends up on Line H of your W-4, the less federal income tax your employer will deduct from your paycheck. If you are self-employed or have other types of income that are not taxed regularly throughout the year, the IRS urges you to make estimated tax payments throughout the year. You are entitled to change the numbers on your W-4 at any time. Simply tell your employer you want to fill out a new one. If your circumstances change or if you owe the IRS or receive an abnormally large refund in a given year, it makes sense to revisit your W-4. The IRS does penalize taxpayers for over- or underestimating their tax due.
Estimated Tax Payments
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IRS Publication 505 contains complete details on estimated tax payments. In relation to the W-4 Form, estimated tax payments are a topic worth considering. Your total income at the end of the year minus credits, exemptions and other deductions dictates the federal tax you are obligated to pay. Self-employed individuals and others who receive income that is not taxed during the year often end up with a large tax bill at the end of the year. An estimated tax payment is tantamount to pre-paying your tax bill over the course of the year. In other words, you are doing the federal tax withholding yourself and sending it to the IRS in monthly or quarterly chunks.
Example
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As Kevin McCormally, the Editorial Director at Kiplinger.com, reports, over 110 million taxpayers received a refund for the 2008 tax year. The average refund was $2,753. While this is a nice chunk of cash to receive all at once, McCormally explains that, based on that average, the IRS took $230 a month out of your paycheck each month. If your year-to-year situation does not change much and you are the recipient of large refunds, consider adjusting your withholding so you get your hands on that money over the course of the year, instead of all at once. You could invest it and earn interest or simply have more leeway when paying your monthly bills.
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References
- Photo Credit tax forms image by Chad McDermott from Fotolia.com
