Understanding the Dreaded W4 Form

What is your gut level reaction when confronted with the task of filling out a new W4 form?

As the go-to for most of my family when it comes to filling out a new W4 form, I feel pretty confident that dread is the standard gut level reaction.

Most of us fill out a new W4 form so infrequently that we lack experience and therefore confidence.

As a result, a lot of W4s are completed based on a hope and a prayer.

Hope that it’s right and a prayer that no taxes are due at the end of the year.

Unfortunately, hoping and praying is not a great planning strategy.

Plan a little more confidently by having a basic understanding of what a W4 is and how it works.

What is a W4 form?

A W4 form is a document, required by the IRS, that employees fill out and submit to their employer.

What is the purpose of a W4 form?

The purpose of the W4 form is to let your employer know how much money to withhold from your paycheck for federal income taxes each pay.

If too little federal income tax is withheld, you will owe a balance when your taxes are filed.

If too much federal income tax is withheld, you will be due a refund (the preferable outcome of filing taxes).

A W4 form helps you find the sweet spot between owing taxes and getting an enormous refund.

My thoughts on income tax refunds.

The standard professional advice concerning tax returns is to not use the IRS as a savings account. Instead, most professionals think it’s best to take the extra money and invest it.

My thoughts differ on that point. If the only way you can save money is by letting the IRS keep it for a year, so be it. It works for you.

However, if you are short on cash all year long only so you can have a hefty refund, you might want to reconsider that strategy.

How does a W4 work?

The filing status that you check in Step 1 part c is what I consider the foundational withholding.

If no other section is completed, income tax will be withheld at the highest rate based solely on the income from the job for which you are completing the form.

Your withholding will not reflect any dependents, second jobs, or anything else that might adjust what is withheld from your pay.

Steps 2, 3, and 4 are what I consider the adjusting steps.

The information in these steps determines if the money withheld is increased or decreased.

Here’s the thing, filling out steps 2, 3 and 4 is optional. After filling out step 1, the form can be turned in to your employer.

However, if you need to adjust the amount being withheld from your paycheck, at least one of the additional steps will need to be completed.

How can you know if enough federal income taxes are being withheld?

Here’s my rule of thumb.

First, understand that this is not tax advice. It’s a starting point. If you want advice, seek out a professional tax preparer.

Look at last year’s tax return.

Find the line that says total tax. For 2022 on form 1040 it was line 24.

Unless your situation has changed drastically, make sure your combined withholdings (spouse, second job) will at least equal that amount.

If there are adjustments to the total tax, and you expect those adjustments to remain the same, your total tax may me a little more or less than what is shown on the total tax line.

Next, take out your last pay stub and see how much was withheld for federal income taxes. (If there are multiple jobs or job earners, include the amount withheld from all jobs.)

Multiply that amount by the number of times you get paid in a year.

That amount should be close to the amount of total tax you owed for the previous year.

Here’s an example for my rule of thumb.

Line 24 on your most recent 1040 shows a total tax of $808.00.

Your most recent paystub shows a total of $50.00 federal withholding (FIT) for the pay period.

You get paid 26 times a year.

26 x $50.00 = $1300.00

Your withholding will be enough to at least equal what your last years’ total tax was.

If you’ve had a change in circumstances, use the IRS Tax Withholding Estimator

If you have had a change of circumstances, the total tax owed could be vastly different than what was on your most recent tax return.

More dependents will lower your total tax.

A new, higher paying job could raise the total tax.

If you’ve had a change in circumstances, the rule of thumb will be wildly inaccurate.

The tax withholding estimator is an app that walks you through all the steps estimating how much tax you need to pay in.

It’s easy to use and only takes a few minutes to fill out.

There’s a bonus at the end.

A filled out W4 is generated and ready to download.

Keep this in mind.

A new W4 can be submitted anytime you need to make a change to your federal income tax withholding.

There is no limit to the number of times the form can be updated and submitted to your employer.

It is totally your responsibility to make sure that the right amount of taxes are being withheld from your paycheck.

Monitor your withholdings to make sure they are correct.

Even if there is an error on the part of your employer, they are obligated only to correct the error, not pay a resulting bill.

True story: I know someone who failed to check their paystub only to get to the end of the year and realize NO federal income taxes had been withheld.

They assumed their employer would have to make it right. They assumed wrong!