Understanding W-4 Withholding Tax Exemptions, Allowances, and Deductions
Determining your withholding tax as a U.S. resident 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 withholdings on your W-4. 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 withholding tax?
If you’re stumped about the meaning of tax withholding, you’re not alone. 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 forms to complete. One of the forms in the stack of paperwork will be a W-4 form.
When you submit Form W-4 to the payroll department, your employer uses the information to withhold the correct federal income tax from your pay. Withholding will be different from person to person. The withholding tax choices you make on your W-4 depend on the number of your eligible children and your income. They vary based on the following:
- Whether you’re married or single
- Your job status (like the number of jobs you hold) and how much you earn at each job
- If you file Married Filing Jointly and your spouse doesn’t have a job
- If your wages from a second job or your spouse’s wages are $1,500 or less
- If you have child or dependent-care expenses and plan on claiming a tax credit for the costs
- If you’ll file your return as a Head of Household
Your withholdings affect your tax return, so it’s important to understand and apply what you’ve learned.
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 are 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.
Changing your withheld tax
A new job is not the only time you should consider filling out a new Form W-4. Certain life events can affect your finances and may possibly change your tax situation.
To be a little more specific, life changes that might impact your withholdings include:
- Birth or adoption of a child
- Increase in interest, dividend, or self-employment income
- Increase in your itemized deductions
- Marriage or divorce
- A new job or second job
- Purchase of a new home
- Starting a small business
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 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, 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.
Is anyone exempt from withholding?
Some people are exempt from withholding. If you didn’t owe federal tax last year and expect to owe none this year, you might be exempt from withholding. For 2022, a single person who isn’t a dependent can have as much as $12,950 in gross income before any tax is due. In 2023, the amount is $13,850.
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:
- Government benefits (like Social Security payments)
- Traditional IRA withdrawals
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.
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:
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, 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.
The tip income you report will appear on your Form W-2, Box 7 (Social Security tips), and Box 1 (Wages).
Getting help with withholding tax?
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. With our many ways to file, you can do your taxes virtually, drop off your taxes at an office, or make a one-on-one appointment in an office!
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