Bonnie Lee for Fox Business writes: With the economic recovery on a steady path, many taxpayers are
looking back at the Great Recession and its impact on incomes, housing
and retirement plans and wondering exactly how best to complete Form W4 – Employee’s Withholding Allowance Certificate.
Form W4 is a good tax planning tool. By dictating how many exemptions
to claim, you control the size of your paycheck and the amount of money
from each check that will be paid to the IRS and to your state’s taxing
agency, if you live in a state that levies income tax.
If you claim too many exemptions, your check will be higher but you
may find yourself owing a large tax liability at year end. Over the
years I’ve had the misfortune of helping folks who didn’t claim properly
and found themselves in trouble. It can be devastating, credit-ruining,
and very expensive to crawl out from under.
On the other hand, if you claim too few exemptions, your check will
be smaller and you may receive a substantial refund from the IRS. But
here’s the thing with those large refunds: conventional wisdom states
that you are giving an interest-free loan to the government for the
year. Some folks don’t really care about that and consider it forced
savings account that can be used to purchase a new gadget or take a
vacation when the refund check arrives. Besides, it’s not like the banks
are paying competitive rates on savings these days.
There is also the possibility of claiming “exempt” on line 7 of the
form, which works if you will have no filing requirement. This applies
to students, part timers making very small incomes, some retired
individuals making very little money and with no other sources of
income. But naturally, it’s complicated. So check the IRS Filing Requirements to find out where you stand.
Otherwise, to determine how many exemptions you should take, complete
the worksheet on page 1 of Form W4. Claiming exemptions for filing
status of Head of Household and for number of dependents is a great
start to deciding how many exemptions will work for you.
However, there are other factors to consider. Let’s say you are
single with three children and can claim the Head of Household status.
According to the worksheet, you will be able to claim five exemptions.
This may work out as a break even for you next April 15. However, there
may be other factors to consider. Perhaps you are also running an online
business on the side making a few grand extra every month. That money
will be taxable and if you are not making estimated tax payments to
cover these extra taxes then you should adjust your withholdings from
five perhaps down to zero. Then again, what if you are using the extra
monies from your self-employment to pay for your health insurance or
fund your IRA account? If so, those are deductions that will
substantially reduce your tax liability. My best advice is that if you
are also self-employed speak with a tax professional to help you
determine the correct number of exemptions to claim.
Page 2 of Form W4 takes into consideration the lowering of your tax
bill via your ability to claim itemized deductions and other adjustments
to income. It also includes a worksheet for families that have two
earners or if you have more than one job.
You might want to pull out a copy of your prior year tax return in order to complete these sections.
Tax law is a very complex subject and can be tricky for even a professional
tax person much less the average taxpayer. If you get confused with all
the worksheets and caveats and exceptions and rulings, then I suggest
you ask a tax professional to help you complete the worksheet and
determine the safest approach to withholding for you.
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