This newly formatted W-4 has left many HR and Accounting professionals scratching their heads. Withholdings should be something you set and forget, but the new system is confusing employees and leaving them unsure what to do. We’re pretty unimpressed with the IRS’ W-4 calculator (linked below), finding it both difficult to use and sometimes misleading, so we’ve compiled some resources to tackle this burning question.
To start, why do you need the new W-4? You’ll only need it if you need to fill out a new W-4 this year, for a new job, a new company, or to update your withholdings. You might want to update your withholdings if certain events transpired: if you owed a substantial amount on last year’s tax return, you received a sizeable refund on last year’s return, or your joint income bumps you up to a higher bracket. This last reason is, by far, the trickiest reason to understand and the sneakiest way that you might end up owing money at tax time.
There are several other instances where a new W-4 may be helpful…
- a change in marital status, dependents, or income
- new home ownership
- receiving dividend income
- seasonal or freelance work
So… How can you tell if enough or too much is being withheld?
First, we recommend using last year as a benchmark. If you have the same job(s) this year as you did last year, with minimal change in wage, last year is probably a good indication. If you owed a lot last year, you definitely need to set aside extra this year, and vice versa. Keep that benchmark in the back of your mind and then use one of these online calculators: Paycheckcity.com, Nerd Wallet or the IRS. Best practice for using these calculators is to grab your last paystub(s) and the last paystub(s) of your spouse, if applicable.
These calculators go much further than just estimating the withholdings for one job, but try to factor in your other income, the job(s) your spouse has, what you’ve set aside so far during the year, and any major deductions you have. They’re not perfect, but they’re a good start.
For more complex situations or if you want to double-check these online calculators, you may wish to utilize the table below from the Tax Foundation, and get out the old calculator.
- To start, take your total expected income for 2020, and find the correct bracket. This is all the W2 and 1099 income that will be reported on your return.
- Use the “fill the buckets” mentality and start with the lowest bracket. Let’s take the example of a $50,000 gross salary.
- The first $9,875 you earn will be taxed at 10%. That’s $987.50 of taxes. Bucket one filled.
- The next $30,250 you earn (your wages over $9,875 but under $40,125) will be taxed at 12%. That’s $3,630 for that bracket. Your total tax so far is the tax for both brackets: $4,617.50.
- The next bucket ranges from $40,125 to $85,525 at 22%. However, with a salary of $50,000, we don’t fill the entire bucket. We’ve already calculated tax on the first $40,125 dollars, so we need to calculate the tax on the remaining highest portion of our salary, the dollars over $40,125, which is $9,875 ($50,000-$40,125). The tax on the last $9,875 of our salary is $2,172.50, which brings our tax total up to $6,790.00.
- This example also holds if you have a $25,000 salary and your spouse has a $25,000 salary, because the tax you owe together filing jointly will be this “fill the buckets” method with your combined salary.
If you haven’t gotten your fill, here’s some additional reading from the IRS…
As always, for more clarity on your books, better tax strategies, and lasting relationships, reach out to Sweeten CPA.