Navigating the New W4
This last week our office has been flooded with calls from clients whose employers have asked them to fill out the new IRS form W4 to determine their tax with holding. While the new form is certainly more complex than the old one, there is a good reason for the change.
In the past, the formulas for with holding had no way of factoring in other things impacting your household taxes, such as the child tax credit and most importantly, additional income sources you may have. For instance, say you are married and have a part time job and make $20,000 a year. A household filing jointly with $20,000 in income would be subject to 0%, so your employer would probably with hold no taxes because all they know about is the $20,000. But let’s say your spouse makes $150,000 a year at their job. Well, now as a family you are in a 22% tax bracket…so now your $20,000 that has 0% holding should actually be having 22% ($4400) with held. This creates a shortfall and results in tax payers in this very common situation owing significant amounts come filing time. The new W4, while still not perfect, attempts to rectify this. Let’s take a look…
Regardless of whether you are married or not, if you have no kids and this W4 is from a job that represents your family’s only source of income, then you can fill out Step 1 and be done with it. For most people, it is not quite that simple so let’s move on to Step 2. If you have two jobs, or a spouse that works you will definitely want to fill out this portion.
For this example let’s assume one of the most common scenarios: you are married with two kids under 17 and your spouse also works. Your salary is $80,000 and your spouse’s is $30,000. You can see Step 2 had three choices, and you can only choose one.
Option (a) directs you to use the IRS with holding estimator. This is a pretty straightforward tool, but I don’t like it for the purposes of filling out your W4 because one of the key questions is “amount of Federal Tax with holding from your last paycheck” and because your with holding is going to change as soon as you turn in the new W4, the figure you used for your calculations will no longer be accurate.
Option (b) is what you will use if your income for this job is significantly different than your spouse’s income or your income from your other job, as it is in our scenario. It guides you to use the “multiple jobs worksheet” so let’s take a look at that…
as intimidating as all of this may look, if you read it carefully and follow step by step it is actually pretty straight forward. If we follow our scenario of $80,000 and $30,000 on the sheet, they intersect at $4440. This figure represents the shortfall of with holding based on having a spouse (or another job) that is being taxed in a bracket lower than it should be because of the issues discussed in the opening of this article. Enter this amount on line 1 of Step 2(b) of the worksheet. Because this is an annual total, we need to break it down to a per paycheck amount. Do that by dividing the amount on line 1 by the number of pay periods in your year. For most people this is 26, so I will use that. This give us a figure of $170.76. This goes on line 4 of the worksheet and then transfers to line 4c of the actual W4. This is the additional amount that will be taken out every pay periods above and beyond what is taken out to cover the tax liability for just this job. It is very important to note that if you chose this option, when filling out the W4 for the OTHER job (or your spouse’s job) you do NOT replicate this. The other W4 will have Step 1 filled out and that is it.
Going back to the last choice for Step 2, option (c). Use this option if your spouse’s income (or the income from your other job) is close to the same amount as the income for this job. If this applies to you, check the box and you are done with part 2. If you chose this option then make sure on your other W4 (or your spouse’s W4) they also check the box.
Next comes Step 3. This is straight forward. If you have dependents, do the math and enter that info here. One thing to note: this should only be done on ONE W4 for the entire family. If both spouses fill out this part then the IRS assumes the child tax credit for both parents and that will result in under with holding.
The final section is Step 4. Most taxpayers either do not need to fill it out, or if they do, the results are immaterial, but for those who have high deductions, we will walk through it. Line 4(a) is where you would put income from other sources that do not have with holding, like interest, self employment income, capital gains, etc. As I noted above, if you have significant income form sources like this, you are most likely better served making quarterly estimates as determined by your tax professional as the calculations for tax on these items is a little more than this simplistic form can compute. 4(b) pertains to deductions on your return above and beyond the standard deduction. If you take the standard deduction and don’t have any other deductions (IRA contributions etc.) you can skip this part. If you do itemize you can can compute the figure for 4(b) on the second half of the worksheet. Transfer the total from the worksheet to line 4(b) of the W4. Line 4(c) reflects the figure we computed in Step 2b (if applicable) above so we have already addressed that.
As with anything having to do with taxes, this is not an exact science, so it is important to keep track of your income and with holding as you move through out the year. We always recommend to our clients that they do a mid-year check in to make sure there are no nasty surprises come tax time. We hope this article has helped you understand the new W4 and if you have any more questions feel free to contact us.