When you were hired at your current job, your employer had you fill out a W-4 form. This form helps the employer take the right amount of taxes out of each paycheck, based on your current filing status and number of personal allowances. It's important to fill this form out as accurately as possible.
If too little is taken out for taxes, you could be hit with a substantial penalty and interest fees for tax underpayment, if you owe more than 10% of your total tax bill, or $1000 when you file. If too much is taken out, your hard-earned money will be held hostage until you file for your tax return.
Many people don't think to later change the W-4 form they filled out when they were first hired by their current employer, but every taxpayer should review their tax withholding at least annually. If you've been there for a few years, there's a good chance that something in your life has changed that may affect your tax situation. If you've had or will have any tax-altering events in your life this year, update your W-4 as early in the year as possible, to be sure to have the right amount of tax withheld. You can request a W-4 update from your employer at any time, as often as you need to.
The W-4 form has a worksheet to figure out how many personal allowances to claim. The number of your personal allowances does not have to match the actual number of dependants or exemptions you will claim when you file your tax return; the W-4 form lets you take additional allowances for Head of Household filing status, child care credits, and other credits that will reduce your tax liability.
If you don't have any tax liability for the previous year, and you meet the IRS requirements, you may not have to have any federal income tax withheld from your paychecks at all. This is more common for the middle and lower income, working parents, who qualify for the Earned Income Credit, Child Care Credit, Child Tax Credit, or the Mortgage Credit.
Also, the IRS website has a nifty tax withholding calculator that is very simple to use. Go to www.irs.gov for the tax calculator, and many other helpful documents and information about federal income tax.
If you have income from a second job, or income from a spouse, it's usually best to only claim allowances for the higher paying job, and no allowances for the lower paying job. This will ensure that enough taxes are taken out during the year. If you can keep your tax refund or the amount of tax owed within the range of a few hundred dollars, you've done a good job of making accurate tax payments.
Update your W-4 form if:
- You received or are expecting a large tax return for this year's filing, and your income and exemptions will remain the same this year.
- You owed so much the last filing that it was a financial burden on you or you were penalized for underpayment.
- You can claim more dependants than last year; you are expecting a baby or are becoming financially responsible for elderly parents.
- You can claim less dependants than last year because you are no longer financially responsible for their care.
- You are entitled to tax credits that will reduce your tax bill, i.e. the mortgage credit or earned income credit.
- You have a change in marital status.
- You buy a house and can claim the interest deduction.
- You start a tax-deductible retirement plan. Remember that Roth IRAs are not tax-deductible.
- You made considerable tax-deductible donations to qualifying charities.
- You have additional income from self-employment, and do not make quarterly estimated payments to cover those taxes.