Internal Revenue Service Form W-4 sets the stage for the “pay as you go” process of paying federal taxes. This is the form you fill out at your job to determine you tax withholding. While some may treat the process only as a task to complete during a new employee orientation session and consider filling out a W-4 form a one-time thing, understanding the consequences of your decisions and taking the time to fill out a W-4 form correctly is essential. In reality, filling out a W-4 form requires care, consideration and following the advice of the IRS and tax professionals. Making good decisions now can maximize your paycheck and minimize your yearly tax liability.
Look at the W4 form from the perspective of its potential impact on your personal financial situation. Setting your withholding too low means you will end the year with a tax bill. If this happens and you do not have the funds on hand to pay the bill in full, the IRS will allow you to pay over time, but it will charge interest on the outstanding balance. Setting your withholding too high means that although you will end the year with a tax refund, you are essentially allowing the IRS to use this excess money interest-free throughout the year. Setting your withholding just right means maximizing your paycheck while ensuring the IRS gets its “fair share.” Additionally, follow the advice of the IRS and review your W-4 annually or whenever you experience a life change such as getting married or divorced, giving birth or adopting a child, purchasing a home, retiring or experiencing an increase or decrease in your annual income.
Review the W-4 form as well as the worksheets and instructions that come with it to ensure you understand its requirements, how to enter information and know what this information entails. Especially important are the terms “filing status” – single, married or head of household at the single rate – which determine your tax rate percentage, and “allowances,” which reduce the tax rate by a specific dollar amount. If you have a spouse who also works outside the home, follow the advice of the IRS and consider her income when filling out your W-4 form.
Know your filing status before starting, have your previous year tax return on hand, get an estimate of child or dependent care expenses you expect to pay during the coming year and estimate your annual income if you have more than one job or both you and your spouse work outside the home. Then, use one of the three worksheets the IRS provides as the most accurate way to determine the number of allowances you should claim. Use the “Deductions and Adjustments” worksheet if you itemize deductions on your annual tax return and the “Two Earners/Multiple Jobs” worksheet if you estimate your combined annual income to be -- as of 2012 -- above $40,000. If you choose the “Two Earners/Multiple Jobs” worksheet, the IRS recommends that the spouse with the highest income claim all the appropriate allowances while the spouse with the lower income claims zero. Finally, use the “Personal Allowances” worksheet if your personal situation fits neither of these scenarios.
Take advantage of help the IRS provides to ensure you fill out Form W-4 accurately. Assistance in the form of interactive worksheets and withholding calculators is available on not only the IRS website but also on personal finance sites. Understand, however, that while withholding calculators can help you get the numbers right, they will only be as accurate as the information you provide.
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