Your W-4 can help avoid surprises during tax season

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You’ve worked hard all year and are looking forward to receiving a tax refund, but tax filing time reveals an unwelcome surprise: Not only do you owe money, but you also have a federal tax penalty to pay. Could the way you completed your Form W-4 be to blame?

The value of a W-4

A W-4, also known as an Employee’s Withholding Certificate, is an Internal Revenue Service (IRS) form typically completed at the start of employment. The W-4 serves as a way for employees to document their specific personal tax situation, including their filing status, and whether they have dependents, work multiple jobs or have itemized deductions.

Employers then use the W-4 to determine the amount of an employee’s paycheck to withhold and remit to the federal government. While this form does not affect the total taxes you pay for the year, it does affect the timing of when those taxes are paid, which may prevent any underpayment penalties during tax time. Something to keep in mind is that W-4s can be updated with employers at any time. The IRS recommends checking your withholding annually, especially following life changes like marriage, childbirth or buying a home.

Reasons why taxes may be under-withheld

The taxpayer did not indicate they work multiple jobs.

If a taxpayer works multiple jobs but doesn’t indicate so on their W-4s, each employer will likely withhold taxes based on the presumption that the income earned from that job is representative of the taxpayer’s total annual income. For jobs which the taxpayer earns significantly less than their primary job, this can result in withholdings based on a marginal income tax rate that is lower than the taxpayer’s actual marginal income tax rate. As a result, the withholding may be less than what’s needed to cover the additional taxes for earned income.

The taxpayer fails to indicate their spouse also works.

When completing the W-4, if a couple indicates they will file jointly and that both spouses work, employers will likely cut the standard deduction in half when determining each spouse’s respective withholdings. When combined, this will allocate the couple’s full standard deduction between the two of them. However, in some cases, a taxpayer may indicate that they file jointly but fail to indicate on the form that their spouse also works. This can result in withholdings based on the assumption that the taxpayer’s income is the couple’s sole income, allocating the couple’s entire standard deduction to the taxpayer.

Correcting a W-4 and making estimated tax payments

Since W-4s can be updated with employers at any time, taxpayers can conveniently adjust their withholding calculations using the form. If a taxpayer works multiple jobs, it’s important that they correctly report their employment and income situation on Form
W-4. This will allow employers to use a consistent, and more accurate both correctly, marginal tax bracket when determining the amount to withhold.

If a taxpayer is filing as “married filing jointly” and their spouse works, each individual must ensure that they have both correctly indicated this employment status on their W-4. In doing so, a taxpayer’s employer should allocate the couple’s standard deduction proportionately to the employee’s income when calculating the amount to be withheld.

For those with itemized deductions, the taxpayer should include only the amount of itemized deductions that exceeds the total standard deduction. For those filing jointly, this amount should only be indicated on one of the couple’s W-4s, based on who earns the most income.

If the above corrections still do not result in the desired refund, they can request additional withholding amounts from their paycheck through their W-4 and use the IRS’s Tax Withholding Estimator.

Alternatively, taxpayers can choose to make quarterly estimated tax payments to the IRS using Form 1040-ES. Quarterly estimated tax payments are typically due on April 15, June 15, Sept. 15 and Jan. 15 of the following year. Regardless of whether a taxpayer has taxes withheld through their employer, makes estimated payments or a combination of both, underpayment penalties may occur if the taxpayer does not pay enough tax to the IRS throughout the year.

According to the IRS, you can avoid an underpayment penalty if:

  • Your filed tax return shows you owe less than $1,000, or
  • At a minimum, you paid the lesser of:
    A) 90% of current year tax, or 
    B) 100% of prior year tax (110% if your adjusted gross income exceeds $150,000, or $75,000 if married filing separately).

Finally, keep in mind that while changes to your W-4 may lead to larger withholdings and potentially a refund at tax time, it may also result in a reduced net pay on your paycheck as larger amounts of taxes will be taken out.

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Because Edward Jones, its employees and financial advisors cannot provide tax or legal advice, we recommend that you consult your attorney or qualified CPA/tax advisor regarding your tax situation. Your Edward Jones advisor can then work together with your team of tax professionals to support your financial strategy and goals.