Since World War II, the federal government has required that employers withhold money from their employees’ paychecks throughout the year to pay federal income taxes. Employees determine the amount of withholding when they fill out a W-4.
In 2020, the Internal Revenue Service redesigned Form W-4. According to the IRS, before the redesign in 2020, the value of a withholding allowance was tied to the amount of each personal exemption. Now, taxpayers no longer claim personal exemptions due to changes in the law, so Form W-4 does not require employees to fill out the number of withholding allowances they are claiming.
Understanding what tax allowances are can save you from potentially getting hit with an unexpectedly large tax bill when you file your taxes. You also want to avoid the interest and penalties imposed by the IRS.
What Were Withholding Allowances?
To determine how much to withhold from your paycheck, your employer uses the amount of your paycheck and the information you provide on your W-4. In addition to indicating whether you will file single or jointly, you used to have to state how many tax allowances you were claiming. Each tax allowance you claimed on your W-4 reduced the amount of your paycheck subject to income tax withholding. If you claimed too many allowances, you would owe money to the IRS come tax time. If you claimed too few allowances, you would receive a tax refund.
How Is Withholding Determined Now?
To determine how much to withhold from your paycheck, your employer uses the amount of your paycheck and the information you provide on your W-4. In addition to indicating whether you will file single or jointly, you will also complete Steps 2-4, if applicable, on the W-4 to help your employer determine your withholding:
- Step 2: Multiple Jobs or Spouse Works – Complete this step if you have more than one job or you are married filing jointly and your spouse also has a job.
- Step 3: Claim Dependent and Other Credits – Complete this step if your total income will be $200,000 or less or $400,000 or less if married filing jointly. Multiply the number of qualifying children you have that are under age 17 by $2,000 and multiply the number of other dependents by $500. Then add the two totals together.
- Step 4: Other Adjustments – If you want taxes withheld from other income, such as interest, dividends and retirement income, that you expect to receive this year, you can list that income in this section. Also, list information about deductions (other than the standard deduction) that you plan to claim this year. You can also include any additional tax you want your employer to withhold from your check each pay period.
Minimum Tax Withholding Required
Generally, you must have tax withholding equal to at least 90% of your tax liability when you file your return or 100% of your tax liability from the prior year. You also meet the tax withholding requirements if you owe less than $1,000. If you don’t have enough income withheld during the year to meet the minimum requirements, you might owe interest and penalties when you file your tax return.
When To File a New W-4
You can file a new W-4 at any time to adjust your income tax withholding. Whenever you have a major life event or a significant change in your income, especially if you have additional income that isn’t subject to withholding, you should review your allowances. For example, if you get married or divorced, start a new job or side hustle, make sure to revisit your withholdings.
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