I’ve always wondered why tax returns had to be so difficult…. They’re really just a reconciliation of the previous year. We start with your income, make some reductions (deductions), and arrive at your taxable income. From there, we can determine your tax liability (tax bill) and can reduce it by any credits you’re eligible for (these count against your tax bill dollar-for-dollar). When we get to the final balance owed, in an ideal world, you’ve already prepaid it via income tax withholdings or estimated taxes. But in real life, we subtract what you’ve already paid from what’s due and if you’ve paid too much, you get a refund — too little, and you have a remaining balance due. Simple right? Of course not, because there’s almost always a variance.
Rarely do individuals get nervous about refunds, but balances due can be stressful and costly if they result in penalties and interest. The best way to avoid penalties, interest, and sleepless nights, is to ensure you’re withholding enough tax (or making estimated tax payments to ensure you’re paying your tax due throughout the year).
If you are a wage earner, chances are you’ve filled out a Federal Form W4 at least once (if your state imposes income tax like NJ does, then chances are you also need to complete a State Form W4 as well). But this is not a “one and done” process. To ensure your withholdings are as accurate as possible, you want to make sure the form reflects your current life circumstances and earning patterns. Therefore, it should be updated as often as necessary. Here are 10 reasons why you should consider reviewing (and possibly updating) your Form W4:
Your income has significantly increased. The Form W4 typically requires additional withholding inputs if you are a very high-income earner. If you experience a significant increase in income, an update to increase your withholdings (or to remove any adjustments that you may not qualify for due to your increased income) may be necessary.
Your income has significantly decreased. If you had previously indicated that you’d like additional tax withheld, or did not adjust for credits or deductions you’d now be eligible for, you’ll want to make these adjustments to reduce the amount of tax that will be withheld.
You’ve taken on a second job. If you have two or more jobs at the same time, there’s a “Multiple Jobs Worksheet” that can help with calculating the total withholdings across the jobs.
You want to have additional tax withheld from your wages to account for income from other sources that tax won’t be withheld on. For example, let’s say you have social security income that is partially taxable because you have other sources of income. If you don’t want to have tax withheld from your social security income, you could increase the tax being withheld from your wages. The government doesn’t require you to have tax withheld from every income source (and there are some income sources where tax withholding is highly unlikely, like capital gains). You can opt to have more tax withheld from your wages to avoid an overall under-withholding situation.
Your tax filing status has changed. Your filing status plays an important role in your tax withholding calculation. Generally speaking, your filing status coincides with your marital status. If you are now married, divorced, widowed or separated, you’ll want to review your W4 form. On your W4, you can indicate if you are Single, Married filing separately, Married filing jointly, Qualifying widower, or Head of household. If your tax filing status has changed, you may want to make this corresponding update on your Form W4. This is especially important if you are going from Married Filing Jointly to Single or Married filing separately, since the joint rates are more favorable than Single or Married filing separately.
Your number of dependents has changed. If there’s been a change in the number of dependents you’ll claim on your tax return (assuming you’re eligible for the child tax credit or other dependent credit), you’ll want to update your Form W4 to reflect this. This ensures that you’re not overwithholding taxes (if you don’t update for an increase in dependents) or underwithholding (by not updating the form for a reduction in dependents).
Your dependents are nearing the age of 17. Currently, the child tax credit is only for dependents under the age of 17. As your dependents creep towards this age, you’ll want to update your Form W4 to move them to the ‘Other Dependents’ line if they’ll remain your dependent. This will ensure you’re accurately planning for this credit.
You have a balance due when you file your tax return. If you file your tax return and have a balance due as a result of not withholding enough tax from your wages, this is a great opportunity to modify your Form W4 to avoid this from becoming a repeat offense.
You’re receiving a large refund due to significant overwithholding. If you find that you’re receiving a large refund and would much rather have your hard-earned money in your pocket as your earn it (rather than giving the government an interest-free loan), your Form W4 can be modified to reduce your withholdings.
You can’t remember the last time you reviewed your Form W4. If it’s been over a year, or you can’t remember when you last updated it, this is your sign to review it. If you’ve experienced any of the above changes, and you did not immediately update the form, this will ensure you don’t go too far without making necessary updates. PRO TIP: Set a reminder to check it at the end of every year. Align the timing with your final check-in with your accountant before tax season begins, and your annual credit report check.
We hope this list encourages you to revisit your Federal (and state, if applicable) W4 forms to ensure your employee withholdings are as accurate as possible. Since this process is certainly not one size fits all, it’s ASE Group’s pleasure to assist in making the necessary modifications to the form(s). If you’re not already an advisory client, now’s a great time to become one since W4 updates are included as part of our advisory support for current clients. You can also use the IRS’ Tax Withholding Estimator tool for W4 completion assistance.