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Don't Just Set It and Forget It: W-4 Tax Form Is a Living Document

Don't Just Set It and Forget It: W-4 Tax Form Is a Living Document
Roman Romaniuk | Dreamstime.com

By    |   Thursday, 30 May 2019 02:44 PM

The 2019 filing season brought into sharp focus just how few Americans understand how to complete Form W-4, Employees Withholding Allowance Certificate.

For example, the news media was apoplectic over reports in February showing that tax refunds were down about 9% compared to 2018. A hysterical cry went out that such data was proof that the Tax Cuts and Jobs Act was nothing more than tax cuts for the rich.

After all, if your refund is down, it must mean your tax hit went up.

There were a number of problems with these reports. For starters, only about 14 million individual tax returns, out of the expected 152 million, were filed in early February. Thus, the sample size was too small to draw any conclusions.

Most notably, however, was the fact that effective January 2018 the IRS changed the withholding tables to reflect the fact that most taxpayers would in fact pay less tax in 2018 than they did in prior years because of the Jobs Act. Said another way, people were getting their tax refunds every month in their pay checks rather than at the end of the year.

Finally, by the time we were at the high tide of filing season in mid March, and nearly 80 million returns were filed, it came to light that the average tax refund was about the same as last year. There was no corresponding celebration by the media to acknowledge that the Jobs Act indeed did cut taxes for most citizens.

In the background of this discussion is a point that I’ve been making for years: people either don’t pay attention to filling out their Form W-4, or they just don’t know how to do it. In light of the firestorm of controversy, the IRS redesigned its withholding calculator and Form W-4 so people might more accurately set their withholding. Now there’s backlash over whether the IRS created a document that, like just about every other tax form, is way too complicated for the average person to read, comprehend and complete.

But it just isn’t that complicated.

Understanding Exemptions and Allowances

Let’s start with understanding the very basics of the form. It is titled (and has been for decades), Employees Withholding Allowance Certificate. With it, citizens inform their employers of the number of withholding allowances claimed for withholding purposes. The fewer allowances claimed, the more money is withheld. The greater the allowances claimed, the less is taken.

Likewise, a person declares his tax return filing status, whether single, married (filing jointly or separately), or head of household. Your filing status impacts whether more or less is taken. For example, if you are a single person with one allowance, more will be withheld than if you are married filing jointly with one allowance.

Suppose you are married with two children. Prior to the Jobs Act, you were entitled to claim an exemption on your tax return for yourself and each dependent. In this example, you would get four exemptions on your tax return. Exemptions operated to reduce your tax liability because each exemption reduced taxable income by about $4,500. Since most people believe that exemptions and allowances are the same thing, they claimed only four allowances on their W-4. Because this misunderstanding caused over withholding, about 80% of all taxpayers overpaid their taxes, leading to a refund of about $3,000, on which the IRS paid no interest whatsoever.

However, allowances and exemptions are not the same thing. An allowance is defined as any tax return item that reduces your tax liability. That includes exemptions but is by not limited to them. For example, standard or itemized deductions also reduce your tax liability. So do tax credits and retirement fund contributions. All of these (and more) need to be included in calculating allowances. I explain this further below.

IRS Redesigns the W-4

In the wake of the confusion and controversy of the 2019 filing season, the IRS redesigned Form W-4. Actually, it’s not the form so much as the worksheet that goes with the form that was redesigned. In my opinion, it’s for the better. The worksheet more clearly walks the reader through the process of figuring allowances. The new design is intended to get people closer to their ideal withholding so it better matches their tax debt. That is to say, they do not over-withhold and thus und up with a big refund (and no interest); nor do they under-withhold and (worse) end up with an unfunded surprise tax debt they can’t pay.

A Walk Through the Form

The remarkable difference between past W-4 instructions and the current version is the way it addresses exemptions. Under the Jobs Act, all personal and dependent exemptions are suspended through 2025. You didn’t claim such exemptions on your 2018 tax return and will not claim them for the foreseeable future. Instead, the standard deduction for all filing categories is about double and there is a new tax credit for certain dependents.

In light of that, the instructions provide a worksheet that guides you through calculating your allowances.

The worksheet factors the following items:

  • Your filing status and marital status,
  • Whether you’re entitled to any child tax credits,
  • Figuring allowances for other dependents,
  • Figuring allowances based on either itemized deductions or the standard deduction (whichever is greater), and finally,
  • Splitting allowances in the case of two-earner married couples, or persons with multiple jobs.

There are a number of steps in the worksheet, but no single step appears to be unduly complicated.

W-4 is a Living Document

Most people file their W-4 upon getting hired for a new job and then forget it. This is one big reason so many people get large refunds. But it is not a file-and-forget form. It’s a living document. It must change as your circumstances change. You must review your W-4 every year, preferably just after filing your past year’s tax return. If you got a large refund or owed money you didn’t expect to owe, you must re-figure your allowances so that going forward, your withholding better matches your tax liability.

Moreover, you should change your W-4 at any point during the course of the year if there are substantial changes to your circumstances.

For example, if you:

  • Get married or divorced,
  • Have a new baby or a child moves out,
  • Stop or start paying for deductible education costs,
  • Buy or sell a home,
  • Begin a new business or close one down,
  • Begin or stop paying substantial medical expenses or charitable contributions,
  • Begin making deductible retirement fund contributions,
  • Being drawing taxable retirement fund benefits, or
  • Change any other behavior that will affect the bottom line on your taxes.

But I Want a Large Refund

People tell me all the time they want over-withholding because they want a large refund. They claim that it’s the way they “save money.” The fact is that it is the world’s worst way to save money. As we all know, the IRS pays you no interest on the over-withholding. Second, you can’t get access to the money on an as-needed basis. You have to file your tax return in order to get the money, and you don’t file the return until March or April of the following year. And finally, when you do file the return, you don’t get all your money back because you are also over-withheld for the first three or four months of the following year, which money you will not get back for a whole additional year later, when you finally file that return. In other words, the IRS always has more of your money than you owe.

But there’s another element of the “savings” plan that is particularly bothersome. We know that about 80% of all taxpayers get a refund. The average refund in 2019 (for tax year 2018) was about $3,000. That means those people paid $250 per month in taxes they didn’t owe. Now, we also know that about one-third of all Americans live pay check to pay check. They usually don’t have enough money to get them through to the next month. For these people, getting a flat tire constitutes a financial crisis. For the life if me, I don’t understand why these people want the IRS to hold their money. It only deprives them of the ability to ease their monthly financial stress. 

How much money do such people pay in late fees and interest on credit card debts? How much do they pay in fines for late utility bills or in added fees to reinstate disconnected utilities? How many are being eaten alive by costly car repairs because they don’t have a reliable car? The fact is that $250 per month pays for a reasonably priced, reliable vehicle, which in turn insures that a person can get to work every day, or perhaps even take a better job that he might not otherwise get because the job is off public transportation routes.

Americans need financial restoration now more than ever before. The process starts with knowing where your money is going, and making decisions with that money to put you on the track to recovery. The first step in that process for most people is to stop paying taxes you don’t owe.

Dan Pilla is a tax litigation specialist with more than 40 years of experience helping people solve their IRS problems. He’s written 15 books, dozens of research reports and more than 1,100 articles on taxpayers’ rights issues, tax policy and administration, and IRS problems resolution. For more information, see: www.danpillabooks.com, and www.taxhelponline.com.

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Americans need financial restoration now more than ever before. The process starts with knowing where your money is going, and making decisions with that money to put you on the track to recovery. The first step in that process for most people is to stop paying taxes you don’t owe.
w4, tax, form, withholding
Thursday, 30 May 2019 02:44 PM
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