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How to Complete Tax Form W-4

Purpose of this article: to help you feel confident in completing your Tax Form W-4

Bullet Point Summary

  • Form W-4 is the form that determines how much federal income tax is withheld from your paycheck.
  • In general, the more personal allowances you take, the less tax will be withheld from each of your paychecks.
  • This form can be updated throughout the year as your situation changes. For example, getting married and having kids during the year changes your filing status and number of dependents.
  • Given the tax reforms passed in 2018, it is vital that you review this document and ensure that you are withholding the appropriate amount. Millions of Americans faced unexpected tax surprises earlier this year.

Overview

The purpose of Tax Form W-4 is to help your employer withhold the correct amount of federal income tax from your paycheck. But if you are like most of us, you submit this form once with your employer upon being hired and never revisit it. This article will talk through why you should revisit this tax form every time your personal financial situations change.

How Does It Really Work?

In general, Form W-4 is focused on honing in on the number of “personal allowances” that you will take. The more personal allowances you take, the less tax will be withheld from each of your paychecks. Conversely, if you claim zero personal allowances you will have the most tax withheld from your take-home pay.

So, it is very important to get the right balance of personal allowances claimed. Claiming too little will mean that too much tax is sent to the government ending in a refund. But claiming too many will lead to too little tax being sent to the government ending in a possible large tax bill come April.

In order to figure out how many allowances to claim, you will need to consider the following:

1. What is your tax filing status?
(a) Married filing jointly
(b) Married filing separately
(c) Qualifying widow(er)
(d) Head of household
(e) Single

2. How many jobs do you have?

3. Do you have any dependents?

4. Will you take any credit for child tax or other dependents?

Once you gather the answers to the three questions above, you are ready to fill out the Personal Allowances Worksheet on Form W-4. Below is a screen shot of what the Personal Allowances worksheet looks like on the actual Form W-4. The next section will walk you through how to complete this form.

How Should I Fill Out Form W-4?

The following video below will walk you through how to fill out Form W-4. Please note that the assumption within this video is that you will not take itemized deductions and you will not need to fill out the Two-Earners/Multiple Jobs Worksheet on Page 4 of Form W-4.

With the new GOP tax plan, the standard deductions have increased so a lot of you may choose this route over itemizing. Always remember though, you should itemize deductions if your allowable itemized deductions are greater than your standard deduction.

[embedyt] https://www.youtube.com/watch?v=Dw8bWZsMsyc[/embedyt]

Closing

The vast majority of people will usually end up with 2 allowances (1 for themselves in Line A and 1 for their filling status in Line B-D), as the video above shows. The purpose of Form W-4 is to help ensure that you pay enough tax upfront so you don’t owe additional taxes later on in April, but this form is far from perfect as it can’t account for every single persons’ tax situation. As a result, I suggest that you always do the following at the beginning of each tax year:

1.      Use the IRS withholding calculator (see here) to calculate how much tax    you should withhold. Fill out Form W-4 with 0 allowances and withhold any additional tax needed from your paycheck by filling out Line 6.

Real example of using the IRS Withholding Calculator. Download PDF here: Mae Mae Nguyen – IRS Withholding Calculator Example.

2.      Use the Federal Income Tax Calculator (see here) from Smart Asset to further analyze your tax liability for the coming calendar year. You want to hone in on the sweet spot where you pay the correct amount upfront and neither owe nor get a refund check in April.

3.      Come see us at Blue Elephant Financial Services with any of your tax planning and tax related questions.

My hope in writing this article is that after reading this, you now feel a bit more comfortable with taxes. Filling out Form W-4 correctly will ensure a less bothersome tax season for you.

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A Simple & Legal Strategy to Reduce Your Tax Burden Today

Purpose of this article: to explain an effective strategy to reduce your taxable income and lower your annual taxes.

Overview:

Each year during tax planning with my clients, the inevitable question always arises:

How can I reduce my yearly tax bill?

And while it can seem like a daunting task, the reality is you can trim your tax bill right now by following this one simple and legal strategy:

Increase your contribution to your employer sponsored retirement plan (i.e. 401(k), 403(b) or other retirement plan).

This simple but effective strategy will allow you to reduce your taxable income and save for retirement at the SAME TIME!

How Does This Actually Work?

The rules of the 401(k) employee sponsored retirement plan are such that you are legally allowed to contribute up to $18,000 annually before tax. And if you are 50 or older, the contribution max grows to $24,000. Each paycheck, your employer will take out money from your paycheck and put it directly into your 401(k) account. Since the money is taken “before tax” it isn’t counted as taxable income when you file your taxes in April.

By increasing your 401(k) contribution, you are effectively deferring tax to a later date in retirement (thus reducing your tax today) because the money you put into the 401(k) goes in tax free, and isn’t taxed until you withdraw in retirement. Furthermore, you not only reduce the total amount you pay in income taxes, but also jump-start your retirement portfolio by putting all of your savings to work immediately.

Financial Example: Bess Napier

Bess makes $50,000 annually and has a 25% tax rate. She decides that she will contribute the maximum $18,000 annually to her 401(k). By doing this she reduces her taxable income down to $32,000 before any itemized deductions or credits, and she saves for retirement!

Put more specifically, investing $18,000 directly into a 401(k) each year grows your retirement nest egg quicker than getting paid the $18,000, paying 25% in taxes, and investing the $13,500 that is left.

For married couples, the math is exactly the same. Each person can contribute $18,000 taking the combined maximum to as much as $36,000. And a married couple over 50 can contribute a maximum of $48,000 ($24,000 each person).

Other Types of Employee Sponsored Retirement Plans

Please note that other employer sponsored retirement plans like a SIMPLE IRAs will have different contribution limits but function the same way as the 401(k). So if you are not maxing out your annual contribution amount, you are paying more taxes than you should. The chart below courtesy of Vanguard has all of the limits:

Courtesy of https://personal.vanguard.com/us/insights/taxcenter/contribution-limits

How can I get this same benefit if my employer doesn’t sponsor a retirement plan?

If you work for a company that does not have a sponsored retirement plan you can still take advantage of some tax deferral. You can open up an Individual Retirement Account (IRA) and make tax-deductible contribution to the IRA. The max contribution here is only $5,500, ($6,500 if 50 and over) which is much lower than the employee sponsored plans, but it is still better than nothing. The only potential problem with an IRA is the fact that tax deductibility phases out for individuals and couples at different levels of modified gross income. The following chart shows all of the various income ranges that cause IRA tax deductibility phase out:

Courtesy of the Hawaii Employees Council

While there are many factors to consider when determining whether or not you are subject to the income-phase out restrictions for IRAs, the point I want to make here is that there are many ways to reduce your taxable income and the best and simplest way to do this is to invest in some retirement vehicle before taxes (i.e. . 401(k), 403(b), other retirement plan, or Traditional IRA).

My hope in writing this article is that after reading this, you can now see the tax benefit of contributing to a retirement savings account. There is not easier way to reduce your tax liability today!

 

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Is A Tax Refund Good or Bad Thing?

Purpose of this article: to explain why tax refunds can be seen as good and bad.

Overview:

I’d like to take a moment to explain something my clients often ask me: Is getting a tax refund each year a good or bad thing?

Each year when you file your tax return with the IRS, one of two things will happen:

1.     You will owe money and have to pay the IRS or

2.     The IRS will owe you money and you will get a refund.

When you get a refund from the IRS this means that each paycheck you received during the year had too much tax withheld and taken upfront. In essence, you have overpaid your taxes during the year.

When you have to pay the IRS this means that each paycheck you received during the year had too little tax withheld and not enough was taken upfront. In essence, you have underpaid your taxes during the year.

The rate/amount that the IRS takes away from each paycheck is determined by Form W-4 [Direct Link to Form: Here], which you typically complete and file with the payroll department of your employer on day 1 of your job, and never revisit.

On an aside … I will complete another detailed write up on how to properly fill out Tax Form W-4, but the point I want to make here is this form determines a big portion of whether or not you will get a refund or pay come April.

Team Bad: Getting a refund is bad because…

• When the IRS writes your refund check, they are just giving you back your own money they owe you, without any interest.

• You have overpaid on taxes throughout the year. It’s your cash that the federal government took from you and is now returning to after months of holding on to it. Oh and they aren’t giving you interest!

• It isn’t the most effective use of your cash flow because you are giving the IRS an interest free loan.

• When we get large sums of money, we tend to splurge because of the Windfall Syndrome. This is because emotionally, our tax refund feels like a windfall, even though this is simply the government returning our money back to us, with no interest.

Team Good: Getting a refund is good because…

• Psychologically speaking, there is no better feeling than getting cash back. Especially large sums of cash.

• If you are disciplined, this huge tax refund can effectively force you to save if you can earmark the refund and send it to a savings account. Same argument can be applied to using the refund to pay down debt.

Blue Elephant’s Verdict:

Getting a refund is economically bad but psychologically good.

In 2015, the average tax refund was roughly $2,860 and approximately 70% of all tax returns resulted in refund checks being issued. The 2016 numbers are not yet published but there is a high degree of likelihood that they will match the 2015 numbers.

Put another way, 7 out of 10 US households that were issued refunds,gave the government $238 each month interest free. This is money that could have been spent building an emergency savings fund. And even if it earned 1% in an Ally Online Savings Account, that would be better than nothing. On top of this, this is money that could have been spent paying down high interest credit card debt.

No matter how you slice it, getting a tax refund is not the best economic use of your precious resource known as cash. But it’s clear that the vast majority of Americans will continue to love their tax refunds. My hope in writing this article is that after reading this, you can now see the economic benefits of saving NO to the tax refund!