You are probably already acquainted with Form W-4, a familiar part of the paperwork involved in serving as an employee. The purpose of the form is to avoid underwithholding of your wages so that you will not have any surprises when you complete your tax return for the year and find out how much you owe.
The form has become overly complicated over the years, and even the IRS acknowledges that in its current 3-worksheet incarnation it produces inaccurate results, especially for those with more than one job in the family. Therefore, we adopted a proprietary approach rather than simply reproduce the worksheets.
The new worksheet asks you to estimate your income, deductions and exemptions (displaying information from your completed 2010 return for additional guidance). It then determines your projected 2011 tax liability and sets your annual withholding to equal that number as well as the withholding tables permit (within $50).
If you would rather use the old method, please click the IRS Instructions tab.
Form W-4 expresses your withholding as "allowances", a number entered on line 5. The more allowances are claimed, the less federal income tax will be withheld. Based on your situation, you may find yourself claiming more than ten allowances. The IRS requires your employer to send the Form W-4 when more than ten allowances are claimed. Should that be the case, you may need to explain to the IRS why you claimed so many. If the high number is due to many dependents or deductions, or losses that already happened, you should have no problems. However, the IRS takes a dim view of people reducing their withholding in mere anticipation of losses. Therefore, if your Form W-4 shows more than ten allowances and there are losses entered on lines I, J or K, consider subtracting one allowance for each $2,500 in losses. You can also use the checkbox provided under line 6 to limit allowances to ten.
The new W-4 worksheet has lines to enter all kinds of income, paralleling Form 1040. If an item (like capital gain) does not apply to you, simply skip it.
Be warned that attempting to cover significant non-wage income (over 25% of total income) through withholding may reduce your paycheck too much. The box in the middle of Form W-4 will show your projected per-paycheck withholding and net pay before state tax and deductions for health insurance and such; make sure to review the numbers carefully.
These are the circumstances under which this worksheet will not calculate correctly:
You are subject to the Alternative Minimum Tax.
You are paid less frequently than once a month.
You can't claim a personal exemption for yourself because someone will claim you as a dependent.
The worksheet calculates two Forms W-4, so the first thing is to check the boxes telling us who these forms are for. If both (or none) of these boxes are checked, we put the name and Social Security number of one spouse on one of the forms and the other's on the other. If only one box is checked, that taxpayer's name and Social Security number goes on both Forms W-4.
On lines A through B1, choose your 2011 filing status and the exemptions you will claim. You can claim one for every family member who is not a dependent of someone else; see Tax Tips for dependents for details. Also, check whether you can claim the additional deductions for people over 65 and/or legally blind.
Since the new W-4 worksheet is a "mini" tax return, you can't use the same worksheet for both spouses if your filing status will be Married filing separately. In that case, use one copy for each spouse and divide all income and deductions between the copies according to the way they will be divided among your separate returns. Note that married people filing separately have to either both itemize or both take the standard deduction.
Suppose you are not sure what your non-wage income or deductions will be in 2011; or you expect them to be about the same and would rather not bother with all the data entry. In that case, the safe harbor method may be for you.
Under this method we will set your tax withholding to equal 100% of your 2010 tax, since the IRS will not charge you interest or underpayment penalties if you pay at least that much (or your underpayment is less than either $1,000 or 10% of 2011 tax). If you have not prepared your return with our software, you will need to override the 2010 tax in the safe harbor section with the right number for the calculation to work.
If you expect your 2011 tax to be substantially higher (or lower) than your 2010 tax, we suggest you don't use the safe harbor method unless you are comfortable with a large tax bill (or refund) come next April 15.
Special considerations apply if your filing status will change from 2010 to 2011, as follows:
If you are switching to joint filing, your 2010 tax for safe harbor is simply the sum of tax on your separate 2010 returns.
If you are switching from joint filing to two separate returns (e.g., you are filing Single or Head of household after a divorce, or you decide to file separately), you have a bigger problem, as you need to re-figure your 2010 tax as if you were Married filing separately.
A lot of times the number in Box 1 of Form W-2 (Federal Taxable Wages) is different from your gross salary. This is because certain deductions from your income are tax-free, while some benefits provided by employers are considered taxable income.
The pre-tax deductions are:
401(k) and 403(b) retirement plan deductions
Deductions for health, life, disability and other insurance
Deductions for "flexible spending accounts" (also known as "reimbursement accounts")
Benefits included in income are:
Cost of employer-paid life insurance for coverage exceeding $50,000
Use of company car for personal needs
Excess pension contributions by employer
If the amounts shown on lines C and D for 2010 differ from your gross wages, you probably have one or more of the above deductions or benefits; take them into account when estimating your 2011 wages.
NOTE: If you get a raise during the year, the Forms W-4 calculated by TaxCut will continue to provide correct withholding unless the raise pushes your income into the next tax bracket.
The worksheet has two Forms W-4-either for two spouses, each holding a job, or for one person holding two jobs, which will suit most people. But what if you have three or more jobs in the family? In this case, combine the earnings (you can easily do this with itemized lists) and enter them as one job.
For the most accurate results, it is best to combine jobs by pay period rather than by earner. For example, if you have two jobs paid monthly and bi-weekly and your spouse has one job paid monthly, it is better to combine the two monthly jobs and enter them as one than to combine yours.
The interplay of tax brackets and allowances for people with multiple jobs can be quite complex. The bottom line is that in most cases you risk underwithholding rather than overwithholding when combining jobs on one Form W-4.
The best practical solution is as follows:
Submit a W-4 claiming zero allowances (line 5) and zero additional amount to be withheld (line 6) to the lowest-paying employer(s).
Submit the Form W-4 we calculated to the highest-paying employer. Note the per-paycheck amount to be withheld.
When the first paychecks under the new Forms W-4 arrive, compare the total amount withheld from all of them to this amount.
Add the shortfall, if any, to line 6 of the highest-paid Form W-4 and re-submit it to your employer.
Enter any alimony you expect to receive in 2011. Please note that child support payments are not alimony and are not taxable.
Capital gains are subject to preferential tax rates. We ask you separately for long-term and 28% rate gains. Because of the preferential rates and other limitations, treatment of capital losses is beyond the scope of this worksheet.
A catch-all category, this line is for miscellaneous income items not previously entered, such as jury duty fees (not turned over to the employer), taxable Social Security benefits, self-employment income under $400, gambling winnings, prizes and awards, and the like.
Look for the "Federal Tax Withheld To Date" or a similar heading on your paycheck. If you have something withheld and do not enter it, we will overestimate your withholding requirement.
Note that it usually takes an employer two weeks to put a new W-4 in effect. Please take this into account when determining tax already withheld and number of pay periods remaining. In other words, you may need to allow for receiving one or two more paychecks before your new W-4's go into effect, and will need to count in the tax that will be withheld on these.