By: AnnaMarie Mock, CFP®
An employee completes Form W-4 to direct their employer as to the amount to withhold for federal taxes. The W-4 can result in an over or underpayment of taxes for the year if not done correctly.
The new design as of 2020 reduces the form's complexity and increases the withholding system's accuracy. Employees that completed the prior version of Form W-4 before 2020 are not required to furnish a new form, meaning employers will continue to use the last version submitted.
As we are heading into the throes of tax season, it is prudent to review your tax situation and complete the new W-4 if you have a large tax refund or tax bill due.
The original W-4 was based on marital status and the number of allowances (the personal exemptions based on the number of people claimed on your return). Previously, the number of allowances taken determined the withholding; as more was declared on the form, less tax was withheld per pay period. The Tax Cuts and Job Act of 2017 eliminated personal exemptions, and in turn, allowances are no longer used as the basis for federal income tax calculation.
Now, the W-4 uses filling status, total family income, number of dependents, and tax deductions to determine the appropriate withholding. The revamped W-4 is relatively simple if the filer has only one income source and claims the standard deduction. The form would require only your name, address, social security number, and filing status.
Complex situations take more thought and some prior-year tax information in each step. Here’s a link to the W-4 to follow along as we move through the steps on the form below:
Step 1: Section to add your personal information.
Step 2: The W-4 captures multiple sources of income with different amounts. Ideally, a W-4 is completed for each source of income, including self-employed individuals.
Step 3: This accounts for your child and dependent tax credit; the tax credits phase out at $200,000 for single filers and $400,000 married filing jointly. You will be able to take the full credit based on your number of kids if household income is below the thresholds.
Step 4: You can only claim one standard deduction regardless of the number of sources of income. The standard deduction can be reflected on only one of the W-4 forms; this should not be considered a deduction for any remaining income.
The new withholding system generates withholding closest to the actual amount to minimize the tax payment due or refund. However, employees can add an additional amount on Line 4(c) for "extra withholding" to reduce the taxes due at filing. This feature removes the need for quarterly tax payments for side gigs.
The IRS's Tax Withholding Estimator resource calculates what the withholding should be for tricky situations. No sensitive information like a social security number, address, or name is required to use the tool.
I recommend reviewing your tax situation on an annual basis and modify the W-4 form as needed. However, as your life evolves, some events will trigger a W-4 review as well.
Change in marital status – affects tax return filing status & thresholds
Having a child – may qualify for a child/ dependent tax credit
Purchasing a home – addition of mortgage interest deduction
Pay changes – the loss or inclusion of income will affect withholding
Addition of consulting/ freelance work – coordination of withholding between full time and part-time work
If you have any questions, please feel free to reach out to the HIGHLAND team.
Author’s Bio
AnnaMarie Mock is a CERTIFIED FINANCIAL PLANNER™ and Partner at HIGHLAND Financial Advisors, LLC, a Fee-Only financial planning firm that offers comprehensive financial planning, retirement planning, employer retirement planning, and investment management. AnnaMarie graduated from Montclair State University with a degree in finance and management and successfully passed the CFP® national exam in 2016. She has been working at Highland Financial Advisors since 2013 as a fee-only, fiduciary Wealth Advisor and is a member of NAPFA.