Whenever you start a new job, your employer will probably ask you to fill out Form W-4. It’s a relatively simple document that requires you to enter your personal information and your tax filing status. But there’s one section of Form W-4 that stumps not only first-time job holders, but also veteran taxpayers:
- Total number of allowances you’re claiming
Section 5 complicates this short little tax form. What the heck are allowances? you think. Are they like the allowance my parents gave me as a child? Am I legally obligated to claim anything? Does it really matter?
Tax allowances do matter because they affect each and every one of your paychecks. If you want to optimize your financial situation, you should know what tax allowances are and how they’ll affect you. Don’t worry—it’s not too difficult to understand the basics.
Here’s a comprehensive overview of all things related to tax withholding and allowances:
- What You Should Know About Tax Withholding
- What Are Tax Allowances?
- How Many Allowances Am I Entitled To?
- How Many Allowances Should I Claim?
- Claiming Allowances for Itemized Deductions
- Claiming an Exemption from Withholding
- 2018 Tax Changes
- Fine-Tuning Your Withholding
What You Should Know About Tax Withholding
Before we discuss tax allowances, you should know what tax withholding is and why the government does it.
The federal government levies an income tax on nearly all American citizens, so a percentage of your annual income is paid to the government. The percentage of tax you pay depends on how much you make; you can view the current tax brackets here.
Let’s say that you’re single and you make $50,000 per year. According to federal tax law, you’d have a 22% tax obligation, so you’d owe $11,000 in taxes each year. It’s highly doubtful that on a $50,000 salary, you’d make $11,000 on a single paycheck, and it’s unrealistic for the government to expect you to pay that much money at tax time. That’s why the IRS doesn’t collect your owed tax on a single date. Instead, they collect your tax in smaller increments throughout the year, kind of like how you pay off a loan.
Most employers withhold a small portion of your paycheck and use that money to pay a slice of your tax obligation. This is known as “tax withholding.” Employers also withhold money to pay for Social Security and Medicare.
If an employer doesn’t withhold taxes from your paycheck, it’s probably because:
- They’ve classified you as an independent contractor
- You’re exempt from federal income taxes
- You have no federal tax obligation (we’ll discuss this later)
But most likely, your employer’s going to withhold money from each paycheck you’re given. Instead of paying $11,000 at tax time, you’ll pay about $450 every month. You won’t pay it, technically, but your employer will take that money from your paycheck and pay it for you.
What is Form W-4?
You’ll claim allowances on Form W-4, which tells your employer how much money to withhold from your paycheck. That’s where tax allowances come in. But first, here’s a brief overview of Form W-4.
Guide to Form W-4
Here you’ll enter your first name, middle initial, and last name. Then you’ll enter your home address.
Here you’ll enter your social security number.
Here you’ll enter your filing status: “Single,” “Married,” or “Married, but withhold at higher Single rate.” The last option is for a married person who’s filing separately from his or her spouse.
You’ll check this box if your name differs from that on your social security card.
Here you’ll enter the number of tax allowances you’re claiming.
Here you can enter any additional amount of income you want withheld from your paychecks.
Here you can claim exemption from tax withholding if you meet both criteria:
- Last year you were refunded all of your withheld income tax because you had no tax liability
- This year you expect to be refunded all of your withheld income tax because you have no tax liability
You’ll sign and date the form near the bottom of the first page. Then your employer will complete the last three sections.
The final pages of Form W-4 contain worksheets that will help you determine how much tax allowance you’re able to claim. We’ll discuss these worksheets in more detail later on in this post.
What are Tax Allowances?
Form W-4 isn’t so complicated, right? Now you’ve only got to learn what tax allowances are and how many you should claim.
A tax allowance reduces the amount of money that’s withheld from your paycheck.
When you claim no allowances, your employer withholds the maximum amount of money. When you claim allowances, less money gets withheld and your paychecks are larger.
How much will a single allowance put back in your paycheck? It depends. The value of a single allowance is based on:
- Which tax bracket you’re in
- How often your employer gives paychecks (weekly, bi-monthly, monthly)
- Your filing status
A certified tax professional can help you figure out the exact number.
How Many Allowances Am I Entitled To?
Technically, you can claim as many allowances as you want—you could even claim 100. However, you could be penalized by the IRS for withholding too much tax. It’s called an “underpayment penalty.” Ideally, you want to pay at least 90% of your owed tax throughout the year. If you withhold so much that you pay less than 90%, you could be penalized.
Page 3 of Form W-4 features a “Personal Allowances Worksheet” that you can use to determine what range of allowances you should claim. Here are the general guidelines:
You can claim fewer allowances than you’re entitled to, but not more. In fact, the IRS can levy a $500 penalty if you claim more allowances than what you’re able (although employers will probably notice errors when you submit your W-4).
For Single taxpayers, your allowances are not proportional to the amount of jobs you work. You’ll have the same number of allowances for all jobs.
Married taxpayers are usually given an extra allowance per dependent.
It gets a little more complicated if:
- You’re Single and you work 2 or more jobs, and your annual earnings exceed $20,000
- You’re married and your total earnings exceed $50,000
If either of those describes your tax situation, you’ll have to use the Two-Earners/Multiple Jobs Worksheet on Page 4 of Form W-4. Don’t be intimidated by this worksheet. All you really have to do is compare your income with the given tables and do some simple math—the instructions will walk you through it.
You might be wondering why you have to jump through these hoops. When you have two jobs, or when you’re filing jointly with a working spouse, the government doesn’t want you to claim allowances at each job. Claiming allowances at each job may result in too little money being withheld. That’s not good for the government; the government needs to collect some taxes during the year for budgeting purposes, and they’re also afraid that people won’t pay their tax bill on time if it’s too large.
If you meet either of the above criteria, the IRS recommends that you claim all your allowances on the W-4 of the highest paying job, and that you claim zero allowances on all other W-4s. The “Two-Earners/Multiple Jobs” Worksheet will lead you to that result.
How Many Allowances Should I Claim?
Now that you’ve determined how many allowances you’re able to claim, you’ll have to decide how many allowances you should claim. Generally, if you don’t claim enough allowances, you’ll overpay your taxes throughout the year and receive a tax refund. If you claim too many allowances, you’ll owe the IRS money when you file your taxes.
Your first instinct might be that it’s better to overpay and receive a tax refund. Most people love tax refunds. And what’s not to love? A tax refund is a lump of money that you get right before summer—and from the IRS, no less! People use their tax refund to pay bills, put in savings, or splurge on shopping.
But here’s the truth: a tax refund might not be the best thing for you, no matter how big your refund is.
If you dispersed your tax refund across all your paychecks, then each paycheck would be larger. Think about it: would you be better off if you made an extra $50-$100 on each paycheck? That’s money you could put toward rent, food, your cell phone bill, or savings.
When you overpay your taxes, you’re basically lending the government money but charging no interest. The money, which is rightfully yours, sits in the government’s pocket all year and you get nothing for it. Wouldn’t it be better to put that money back into your paychecks?
On the other hand, you don’t want to withhold too much money from your paychecks. If you withhold too much money, then you’ll have a very large bill come tax season. Larger bills are harder to pay.
The best strategy is to withhold close to the actual amount of money you’ll owe in taxes. Aim for either a small refund or a small tax bill. Either of these means that you received closer to your fair share of money on all your paychecks.
Do you want a higher tax refund? Or do you want high paychecks? Follow these guidelines to achieve either.
- 0: Will most likely result in a tax refund
- 1: Will get you close to withholding exact tax obligation—you might owe a small amount
Single with One Job, Multiple Jobs, or Married Couple with No Dependents
- 0: Will most likely result in a very high tax refund
- 1: Will most likely result in a moderate tax refund
- 2: Will get you close to withholding exact tax obligation—you might owe a small amount
Married Couple with Dependents
If you claim 0 allowances or 1 allowance, you’ll most likely have a very high tax refund. Claiming 2 allowances will most likely result in a moderate tax refund.
If you want to get close to withholding your exact tax obligation, then claim 2 allowances for both you and your spouse, and then claim allowances for however many dependents you have (so if you have 2 dependents, you’d want to claim 4 allowances to get close to withholding your exact tax obligation).
Head of Household with Dependents
You’ll most likely get a tax refund if you claim no allowances or 1 allowance. If you want to get close to withholding your exact tax obligation, claim 2 allowances for yourself and an allowance for however many dependents you have (so claim 3 allowances if you have one dependent).
Claiming Allowances for Itemized Deductions
When you file your taxes, you can opt for the standard deduction or you can itemize deductions. The standard deduction gives you a pre-determined tax deduction based on your tax bracket. If you choose to itemize deductions, you can claim tax deductions based on a variety of factors that might apply to your tax situation. Examples of tax deductions include: medical expenses, state sales tax, and charitable contributions. Itemized deductions can sometimes reduce your taxable income even more than the standard deduction.
There are two things you should remember:
- The “Personal Allowances Worksheet” on Form W-4 assumes you’re going to be claiming a standard deduction, not an itemized deduction
- If your itemized deduction is greater than the standard deduction, even less of your income will be taxable—which means that your tax obligation will also be reduced.
If itemized deductions are going to reduce your tax obligation, then you might want to claim additional allowances to compensate for it, otherwise you’ll be overpaying your taxes by a wide margin. Unfortunately, the “Personal Allowances Worksheet” doesn’t account for this.
Thankfully, you’re usually able to claim additional allowances when you itemize deductions. You’ll have to use the “Deductions, Adjustments, and Additional Income Worksheet” on Form W-4 (page 3) to determine how many extra allowances you get.
If you’re still uncertain about how many allowances you should claim, consider hiring a financial advisor. A financial advisor can pore over your finances and recommend the right number of allowances to suit your financial goals.
Claiming and Exemption from Withholding
You might be eligible to claim an exemption from tax withholding. You’re only able to claim an exemption if you meet two criteria:
- The IRS refunded you all your withheld federal income tax last year
- You expect to be refunded all your withheld federal income tax this year
Why would the IRS refund all your withheld tax? Usually, it’s because you’re not making high-enough income. You’re exempt from paying taxes if you’re:
Filing Status Annual Income No More Than
|Single under age 65||$12,000|
|Single age 65 or older||$13,600|
|Married filing jointly, both spouses under 65||$24,000|
|Married filing jointly, one spouse age 65 or older||$25,300|
|Married filing jointly, both spouses 65 or older||$26,600|
|Married filing separately, any age||$12,000|
|Head of household under age 65||$18,000|
|Head of household age 65 or older||$19,600|
|Widow(er) under age 65||$24,000|
|Widow(er) age 65 or older||$25,300|
The above criteria doesn’t automatically mean you’re exempt from withholding—first, you must have had all your withheld income tax refunded. Only then can you claim exemption for the following year, so long as your financial situation hasn’t changed.
2018 Tax Changes
The Tax Cuts and Jobs Act of 2017 brought major changes to American tax laws that may affect how you claim allowances.
The new tax law nearly doubled the standard deduction, so taxpayers now have more incentive to choose the standard deduction over itemized deductions. Now, many taxpayers are more likely to receive a greater deduction by choosing the standard deduction. This is compounded by the fact that the new tax law limited the amount of itemized deductions that a taxpayer can claim. Deductions that were eliminated include:
- Personal exemptions
- Deductions for unreimbursed employee expenses
- Moving expenses
- Tax extenders
Furthermore, some deductions were restricted: for example, you can no longer claim unlimited state and local tax deductions. If you’ve been accustomed to claiming deductions in the past, carefully review your finances and see whether or not itemized deductions will still prove advantageous to you.
Fine-Tuning Your Withholding
Most of the time, you’ll submit Form W-4 to your employer when you begin a new job. But you can and should update your W-4 throughout the year if your financial or life situation changes significantly.
Consider updating Form W-4 for all major life events, including:
- Birth or adoption of a child
- Losing a job
- Buying or selling a home
These situations may change your tax filing status, or they may change your income significantly. As we discussed earlier, your filing status affects the number of allowances you’re able to claim, and if your filing status changes then you may want to adjust the number of allowances you’re claiming so you’re able to withhold your preferred amount of tax obligation.
But you may also want to change your filing status if you have a significant change in income, or if you’re saddled with greater financial obligations.
Let’s say that you have a child. A child is a significant financial responsibility, so you’re able to claim an extra allowance on your Form W-4. By updating your form and claiming the additional allowance, your paychecks will be boosted so that you’ll get more money in your pocket to provide for your new child. Always account for new dependents because they can significantly affect your tax return.
Or, let’s say you’re married, filing jointly, and both you and your spouse work. Last year, your spouse made more money so you claimed both allowances on her job. If you got a promotion that gave you higher income than your spouse, you’d want to update your Form W-4 and claim allowances on your job, instead.
Update your Form W-4 for all major financial changes in your life, such as:
- Realizing significant capital gains
- Cashing in stock options
There’s one more important aspect of Form W-4 that we haven’t discussed yet. Section 7 enables you to withhold a specific dollar amount from each paycheck. This dollar amount is in addition to your allowances. You’re able to withhold any extra amount you wish.
Why would you want to withhold extra? The most common reason taxpayers withhold extra money is to cover their tax obligation at the end of the year. Obviously, that’s mostly for anyone who expects to pay some taxes at the end of the year. If you’re claiming few allowances and expect to get a large refund, you’ll have little reason to have extra money withheld. But if you plan on withholding close to your actual amount of owed taxes, it helps to have a little money put away to pay the bill when tax season comes around.
You might also want to withhold extra money if you’re self-employed. Taxes usually aren’t withheld from self-employed taxpayers, and so it’s a smart idea to compensate for that by withholding money for taxes using Section 7.
- Most employers withhold a small portion of your paycheck and use that money to pay a slice of your tax obligation. This is known as “tax withholding.” Employers also withhold money to pay for Social Security and Medicare.
- A tax allowance reduces the amount of money that’s withheld from your paycheck.
- You can claim allowances on Form W-4, which you’ll usually fill out when you begin a new job.
- You can technically claim as many allowances as you want, but if you withhold too much money then you could be penalized by the IRS.
- Generally, the number of allowances you should claim is dependent on your filing status, income, and whether or not you claim someone as a dependent.
- Typically, you can either claim more allowances and get higher paychecks, or claim less allowances and get a larger tax refund.
Update Form W-4 after any major life events that affect your filing status or financial situation.