Understanding W-4 tax withholding: Allowances, exemptions, and deductions
Determining your withholding tax as a U.S. taxpayer isn’t the easiest task. But if you landed a new job or had a major life milestone (a new baby, marriage, or employer), it’s a smart idea to revisit the federal tax withholding on your Form W-4. the federal tax withholding on your Form W-4. (Note: sometimes people think of this as withholding tax, but the true wording would be “tax withholding”). Because how much you withhold on your personal income tax is directly related to your refund — or what you may owe at tax time, it’s worth the time to understand what it’s all about.
What is tax withholding?
If you’re stumped about the meaning of tax withholding, you’re not alone. It’s not an everyday concept (which may be why some people ask “what is withholding tax”). It’s not an everyday concept. But you may have encountered it when starting a job. It’s at that time your employer will send you multiple tax forms to complete. One of the forms in the stack of paperwork will be a W-4 form.
Withholding is the amount of federal income tax withheld from your paycheck. When you submit Internal Revenue Service (IRS) Form W-4 to your employer, your employer uses the information to withhold the correct federal income tax from your pay. The amount of federal income tax withheld will be different from person to person. The amount of withholding tax you request on your W-4 depends on two factors:
- The amount you earn, and
- The information you include on your W-4.
The information you enter on your W-4 can include:
- Your filing status
- The number of jobs you (and your spouse if filing a joint return) hold
- How much you earn at each job
- How much your spouse earns, if filing a joint return
- Additional income from other sources and any federal tax withholding
- Credits and deductions you claim, such as the child tax credit
- Whether you plan to claim the standard deduction or itemize your deductions
- If you have child or dependent-care expenses and plan on claiming a tax credit for the costs
Your withholdings affect your tax return, so it’s important to understand and apply what you’ve learned.
When and how to check your withholding
There’s no required timeframe from the IRS to check your withholding, but there are a few times when it makes good sense to do so. Generally, it’s best to revise your Form W-4 after major life events such as:
- Starting or ending a job,
- getting married or divorced,
- purchasing a home, and
- having your number of dependents change – like when a baby is born or adopted or when your adult child is no longer considered a dependent – or reaching age 17.
What about annual updates to your withholding? It can be a good idea to check your withholding once a year — ideally at the beginning of the year and at the very latest June. That way you have time for any adjustments to take hold during the tax year. For example, let’s say you want to end the year with a tax refund. If you don’t have enough tax withheld each paycheck each period, you may be “off track” for a refund and may owe at tax time. By adjusting your withholding at mid-year, you’re giving yourself several months of pay periods to catch up and get back on track before the tax year is over.
You can use our W-4 Calculator to determine how your withholding adjustments can impact your tax outcome.
How many allowances should I claim?
If it’s been several years since you’ve completed a W-4, you may remember trying to figure out your withholding allowances. Once you start to look at a recent W-4, you’ll see that withholding allowances and allowances on taxes aren’t even mentioned on the form.
What gives? Well, in 2020, the IRS launched a new form that did away with the method of withholding allowances. In fact, concepts and questions such as dependency allowances, number of exemptions and “how many exemptions should I claim?” have all gone by the wayside.
The good news is that there are still ways to adjust your tax withholding on your tax return, even if withholding allowances and claiming exemptions as a concept no longer exist. Read on to understand the current world of withholding tax.
Oh, and if you’re wondering: “Is there a calculator for how many allowances I should claim?” – you’re in luck. Our W-4 calculator walks you through the current form. Even better, when you’re done, you’ll have a completed form to take to your employer. (Employers can use IRS publication 15-T, Federal Income Tax Withholding Methods, to figure out the amount of federal income tax withheld for employees.)
When this was the tax law, if you didn’t file a W-4, your employer accounted for withholding tax from your wages at the highest rate—as though you’re single with zero allowances on taxes.
How to change your tax withholding
When you complete the form, there are three main elements that impact how much tax will be withheld from your pay — and will ultimately factor into your tax return:
- Accounting for all jobs in your household. If you have more than one job or are married, you’ll need to consider all your income —and if some jobs bring in more money than others. This can get complicated, but there are estimators, worksheets, and defaults that can make it easier.
- Claiming children and dependents. Essentially, this is accounting for potential credits that you may be able to claim.
- Making any other tax adjustments. This could be for any side income or additional income (ex. investments) that you have, extra withholding, or deductions that you want to account for.
Completing a new W-4 can get complicated, but it’s important to get your withholding right. In fact, if you withhold too much during a tax year, you can end up with a large tax refund. If you withhold too little, you can create a balance due and potentially an underpayment penalty. If you need more guidance, check out our post about how to fill out a W-4.
But don’t forget—our W-4 calculator can walk you through the whole form.
Exemption from withholding: Who qualifies?
Some people are exempt from tax withholding. If you didn’t have any federal tax liability last year and don’t expect to this year, you might be exempt from withholding.
Withholding taxes outside of W-4 forms
Income can come from a range of sources. Below are some scenarios where you might fill out withholding tax forms, other than a traditional W-4.
Withholding and retirement income
After you’ve earned your last paycheck, you may still have income coming your way. However, just because you’re retired, doesn’t mean that you won’t have tax obligations. For that reason, withholding tax applies to several forms of retirement income.
In fact, you can have federal income taxes withheld from your:
- Annuity/pensions
- Government benefits (like Social Security payments)
- Traditional IRA withdrawals
Form W-4P
You’ll fill out Form W-4P if you have a pension, individual retirement accounts, or annuity payments. But recipients of Form W-4P need to complete withholding forms for pension benefits, otherwise taxes are withheld based on a single filing status with no adjustments.
Form W-4V
If you receive government payments like unemployment compensation, Social Security benefits, Commodity Credit Corporation loans, or certain crop disaster payments, you will get a voluntary withholding request form, otherwise known as Form W-4V.
On the form, you’ll be instructed to choose one of these rates:
- 7%
- 10%
- 12%
- 22%
Lump-sum pension payout
If you’re closing out your retirement account, you’ll receive what’s called a lump-sum payment from your retirement plan. When receiving this money as a check or paid to your bank—even if you later plan to add it back to another retirement plan (known as an indirect rollover), the plan administrator must withhold 20% for federal income taxes.
If you opt to have the lump sum paid to another qualifying plan or IRA (called a direct rollover), you can avoid the 20% withholding. Check with your employer about their process or forms for a direct rollover.
Tips and personal income tax withholding
Working as a server, barista, home cleaner, or other job where you collect tips? You may already know your tips are considered taxable income, so withholding applies here, too.
Ding! If you receive $20 or more monthly in tips, report that income to your employer. If you receive less than $20 in tips for a calendar month, then you aren’t required to report your tips to your employer for withholding but you will still have to report those tips on your tax return. Your employer might also report allocated tips.
The tip income you report to your employer will appear on your Form W-2, Box 7 (Social Security tips), and Box 1 (Wages). Allocated tips are reported in Box 8.
Get help with federal tax withholding
If you’re a U.S. resident and need guidance on withholding taxes, use our W-4 calculator. For hands-on support, get help from a tax professional.
Whether you choose to file with a tax pro or file with H&R Block Online, you can rest assured that we’ll get you the biggest refund possible.
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