The W-4 is the form you file with your employers to show whether you are married or single and how many withholding allowances you want to claim. The more allowances, the less tax is withheld.
It's wise to review your withholding allowances at least every couple of years. The tip-off that something is amiss happens when you get a big tax refund (over $500) or owe a healthy amount (more than 10% of your total tax bill) when you file.
Each allowance you claim exempts from withholding the same amount of income that an exemption knocks off your taxable income – $3,300 in 2006.
IRS regulations control how many allowances you can claim, and you can be fined if you deliberately claim more than you deserve. It's clear from the fact that the most taxpayers get refunds every year, however, that most taxpayers claim too few allowances rather than too many. If you're in that group, consider taking the time to closely match withholding to your actual tax bill.Undoubtedly, there are plenty of willing victims of over withholding, including taxpayers who see it as a convenient means of forced savings. There are, however, plenty of better ways to save. Uncle Sam doesn't pay interest, and inflation gnaws away at the value of your money while it's hibernating.
Whether you decide you need more or less money withheld from your pay, filing a new W-4 with your employer – not the IRS – will trigger the change, usually within a month. Your employer is required to withhold income tax from your wages as if you are single with zero allowances if you do not submit a Form W-4.
Visit our website at www.hrblock.com to use our Withholding Calculator before filing a new W-4 with your employer.
TaxCut includes a Form W-4 worksheet to help you pinpoint the number of allowances you should claim.
In addition to the allowances you claim for yourself and your dependents, add extra ones if:
You are single and have only one job;
You are married, have one job and your spouse isn't employed; or
Your wages from a second job or your spouse's wages are $1,000 or less.
You have at least $1,500 of child- or dependent-care expenses and will claim a tax credit for these costs.
You will file your return as a head of household.
You will claim child credits (which are worth $1,000 for each eligible child). How many allowances you claim depends on the number of eligible children and your income.
Taxpayers whose 2006 adjusted gross income exceeds $150,000 ($75,250 for those who are married filing separately) must take into account the fact that the law restricts their itemized deductions.
Making all those estimates might sound like more trouble than it could possibly be worth, but IRS restrictions can simplify the job. Begin with your tax return for the previous year. If you can reasonably expect your write-offs to be at least as high for the current year, you can use last year's figures for the W-4. You can use higher figures only if you can point to something that justifies the increase, such as in the following examples:
You buy a new home for which mortgage interest and property-tax payments will be higher than your previous write-offs in those categories.
You are divorced this year and have to pay alimony, a tax-deductible expense you didn't pay in earlier years.
You suffer a substantial loss in the stock market. You may use your estimated net loss to raise the number of allowances claimed.
The rules don't permit adjusting withholding in anticipation of a tax-saving event. If you are simply worrying about a stock loss or are considering making a big charitable contribution, for example, you can't reduce withholding.
Use the W-4 form to figure the right number of allowances to claim.
This is a special brand of withholding that's tailor-made for new college graduates who sign on for their first full-time job around mid-year. The part-year method sets withholding according to what you'll actually earn during the part of the year you work, rather than on 12 times your monthly salary. That can make a significant difference in how much is held back from your checks.
The part-year method can be used by anyone who expects to work no more than 245 days – approximately eight months – in continuous employment during the year.
Unfortunately, TaxCut can't do this one for you. You must give your employer a written request that the part-year method be used. Employers don't have to comply, but if your employer does, you'll get more of your pay as you earn it.
If your income for 2006 will exceed $850, your parents can claim you as a dependent on their return and if you have more than $250 of "unearned" income – such as interest on a savings account or mutual fund dividends – you can't be exempted from withholding.
If you can't be claimed as a dependent, you can make much more and still be exempted from withholding. The key is that you owed no federal tax for the previous year and expect to owe none in the current year. For 2006, for example, we estimate that a single person who is not a dependent can have as much as $8,450 in taxable income before any tax is due.
If you make $200 a week or more and claim the exemption from withholding on your W-4, your employer has to send the form to the IRS. As with taxpayers who claim more than ten allowances, the IRS may ask you to justify your claim.
If both you and your spouse have jobs, you figure the number of allowances you are entitled to together, and then split the allowances however you choose. They are usually worth more–in terms of reduced withholding –when claimed by the higher-paid spouse.
Many married couples — particularly higher-earning couples — are plagued by under withholding rather than over withholding. The W-4 takes this into account with a special worksheet for working couples. Based on the income of each spouse, this worksheet walks you through the process of eliminating allowances the other rules say you deserve.
It's completely up to you whether the IRS gets to withhold from regular payments from a company pension or annuity, from withdrawals from a traditional IRA or from your Social Security benefits. With Social Security, you have to ask for withholding; with other retirement plans, you must file a form with the payer to stop any withholding. The company that pays your pension or annuity should periodically remind you of your option to block withholding and tell you how to do it.
Withholding might make life easier if the alternative is to make quarterly estimated tax payments. Except for Social Security, the amount held back from pension and annuity checks is based on information you provide on a form W-4P, just as withholding on wages is controlled by a W-4.
Voluntary withholding from Social Security benefits is controlled by a Form W-4V you file with Social Security. On that form, you clearly are given a choice of rates: 7%, 10%, 15% or 25%.
There is a withholding rule that applies to lump-sum payments from company retirement plans – the kind of payment you might receive not only when you retire, but also if you quit or are laid off.
If you choose to receive a lump-sum check from the retirement plan the plan administrator is required to withhold 20% in taxes. This is true even if you intend to roll the money over into an IRA or another pension plan within the allowed 60 days.
This applies to plan distributions that go to employees who retire, quit or lose their jobs. This is a forced prepayment of a tax bill you may or may not owe. If you do roll over the payout yourself, no tax would be due.
Although you can still legally handle the rollover yourself – by taking the payout and depositing it in a rollover IRA within 60 days – the withholding rule might make that cumbersome to do. If you choose to receive a check and do the rollover yourself, 20% of your distribution will be withheld. Unless you can come up with an amount equal to the 20% withholding from another source, you won't have enough to put the full payout amount into an IRA. Any part of the payout that's not in an IRA within 60 days will be taxed and possibly penalized.
In order to avoid having the 20% withheld from your distribution, simply tell your employer that you wish to roll the funds over and provide them with the information they need in order to effect the rollover. They will then do a transfer and the event will be tax-free to you.
In some rare circumstances (you must have been born prior to 1936 for this to apply), however, rolling the money into an IRA to avoid withholding could be a costly mistake. You could forfeit any right to use a special tax computation method (ten-year averaging) to reduce the tax on a lump-sum distribution.
If you receive more than $20 a month from tips, that income is subject to withholding, too. You report the tips to your employer, who takes them into account when figuring how much to withhold from your wages.
There are special rules to encourage voluntary compliance. Basically, the law assumes customers tip at an average rate of 8%. If restaurant and bar employees don't report to their employer tips totaling at least 8% of the establishment's gross receipts, the employer has to do it for them.
Waiters and waitresses are still expected to report their actual tip income, whether it's more or less than their share of the 8% kitty. Those who report less, however, should be prepared for questions from the IRS. (The tip-allocation rule applies only to establishments with ten or more employees where tipping is customary.)