Behind the Makeover of Form W-4: How it Impacts Your Tax Refund

Form W-4, which instructs your employer on how much tax to withhold from your paycheck, received a makeover at the start of 2020. It’s the first major redesign of the form in 33 years, dating all the way back to 1987. The adjustments simplified the form and implemented the tax code changes that went into effect as part of the Tax Cuts and Jobs Act of 2017.

To some, the new design may seem a bit overwhelming. But, in reality, it’s a lot more straightforward. Let’s take a look at the main changes.

Allowances are no longer a thing

While Form W-4 endured some serious body work this year, the main change to call out is the elimination of allowances. And considering allowances were the basis of payroll withholding for almost forever, this is quite the change.

Previously, if you claimed more allowances, less tax was withheld from your paycheck. If you claimed less, more tax was withheld, and your paycheck shrank in size. In the latter scenario, you’d receive whatever money you overpaid throughout the year as a tax refund when you filed your return.

Now, employees simply use Form W-4 to provide their employer with the information needed to determine the amount of tax to withhold. That includes details like your expected filing status, income from any other jobs, number of dependents, and the tax deductions you plan to claim. Once your employer has that information, they will do the calculations to determine how much to withhold from your paycheck.

This is a much simpler process for most people. So, sayonara allowances!

The need to complete a new Form W-4 is debatable

If you’re wondering whether you need to rush to update your Form W-4, don’t sweat it. There’s a good chance you don’t need to update anything. Most employers are not requiring their employees to submit a new W-4 form for 2020. If you’re happy with your tax outcome, there’s no need to change a thing.

That said, the ideal state is for your annual withholding and your tax liability to be very similar. That means when you file your tax return, you don’t end up owing a lot or receiving a large refund. Because remember, a large refund just means you gave the IRS an interest-free loan the entire year. It’s not free money from the government. You worked for it the prior year. Therefore, if you want to change your tax outcome – perhaps to lower your refund and keep more of your hard-earned money in your pocket – then submitting a new Form W-4 is a smart move. Check out the IRS’ Tax Withholding Estimator to determine if you should update your information. It’s most beneficial to make any changes as early in the year as you can.

If you experienced a major life change this year, that’s another good reason to update your Form W-4. That includes events like getting married or divorced, having a baby, adopting, or buying a home. It may even be worthwhile to update your information if you or your spouse received a significant pay raise or pay cut.

The complexity of the form is based on your tax situation

The level of difficulty in completing the new Form W-4 is entirely based upon the complexity of your tax situation.

If your tax scenario is rather simple, filling out the form will be rather simple. And by simple, we mean you likely have one job and are not filing a joint return with a spouse, do not have any dependents, do not plan to itemize, and do not have non-employment income. If that’s you, you just need to provide your name, address, Social Security number and filing status, and then sign and date the form. That’s it – you’re all done.

But if your taxes are a bit more complicated – or a lot more complicated – things get a trickier. It will likely take you more time to complete the new Form W-4 than it took you to complete the old version. That’s because you now have to dig up information about your spouse’s income and your dependents as well as any tax deductions and credits you want to claim.

To find that information, first try looking at your last year’s tax return. Most of those details are listed there. You’ll need to find items like the total of your deductions last year and the total of any non-wage income you reported. We assume you don’t remember that information off the top of your head (because who does?), so it may take you some time to compile what you need.

You can cover your side job

The old Form W-4 didn’t allow space for any self-employment income, which then didn’t let a person withhold additional money from their paycheck to account for their income tax liability on their self-employment earnings. With the new Form W-4, that’s entirely different.

Now, if you have a side gig as a freelancer or another form of business, you can use the new Form W-4 to have income taxes taken out of your regular job’s paycheck to cover your side job taxes. If you opt to have additional money taken out to cover that tax liability, you then do not need to pay estimated taxes for that second job during the year.

That said, you always have the option to pay the taxes for your self-employed income via quarterly estimated tax payments if you prefer to manage that tax liability the more traditional way.

Note: self-employment income should not be added on Line 4(a) as “other income”. That line pertains to income that isn’t from a job, such as interest, dividends and retirement income.

Spouses and second (or third) jobs are handled differently

If you have a spouse or multiple jobs where you receive a W-2, then pay attention to this. Having multiple jobs or a spouse who also has a job affects the amount of tax you should have withheld from your paycheck. Why? Because tax rates increase as income rises, and only one standard deduction can be claimed on a tax return. But what does that mean? Let us explain.

If you have more than one job or file a joint return with your working spouse, more money should be withheld from the combined pay for all the jobs than would normally be withheld if you only had one job to consider. Therefore, you need to make adjustments to your withholding to avoid owing additional tax – and possibly penalties – when you file your tax return.

But that’s not new information? Yeah, we know that. What is new, however, is the way it’s handled on the W-4 form. The new form is much more straightforward and direct compared to the old version when it comes to factoring in additional jobs and working spouses. Step 2 of the redesigned Form W-4 lists three options for you to choose to make the right withholding adjustments. The form also includes a multiple jobs worksheet that helps you to accurately compute the right withholding when you and your spouse both work or when you have multiple jobs on your own.

It’s easier to account for credits and deductions

With the updated Form W-4, it’s now easier to adjust your withholdings to account for any tax credits or deductions you plan to claim, like the child tax credit or any estimates for education tax credits.  That’s important because including credit and deductions on the form can decrease the amount of tax withheld, which in turn increases your paycheck and reduces the refund you may get when you file your return. The revised form now has clear lines to add that information.

When it comes to adding deductions, you should only enter the deduction values you plan to claim outside of the standard deduction. That includes deductions such as those for student loan interest and IRA contributions. Do not list the standard deduction as that will cause an error in the amount of tax withheld from your paycheck.

Additionally, if you anticipate your itemized deductions will be greater than the standard deduction, you can use the deduction worksheet for Line 4(b) to enter the expected total of those deductions.

Withholding exemptions are still a thing

You can still claim an exemption from withholding on the revised W-4 form, but there is no longer a specific line for it. If you qualify for an exemption, you can claim it by writing “exempt” in the space below Line 4(c).

Curious if you qualify for an exemption? You do if:

  • You had no federal income tax liability in 2019, and
  • You expect to have no federal income tax liability in 2020.

Let’s be clear, though. If you claim an exemption, you’ll have zero income tax withheld from your paycheck. That could result in you owing taxes when you file your return. You also could be hit with an underpayment penalty. That means you should enter “exempt” at your own risk.

Additionally, it’s important to note if you want to claim an exemption every year, you must resubmit Form W-4 to your employer each year. It doesn’t carryover from year to year.

Increasing your refund is still possible

The new withholding form is designed to create the most accurate withholding. And that, ultimately, means producing the lowest tax payment or refund when you file your return. But you still have control over that outcome.

If you desire to increase your refund, simply add an additional dollar amount to be withheld from your paycheck on Line 4(c) for “extra withholding.” You can use the IRS’ Tax Withholding Estimator to help you determine how much extra you should write in based on how big you want to make your refund.

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