- Plans & Services
- Tools & Tips
- About Us
Each time you start a new job, one of the first things you do is complete a Form W-4. Do you know why?
Your employer uses your Form W-4 to ensure the correct federal income tax is withheld from your paycheck. Have you ever wondered why you pay a federal income tax? To find the answer, you need to take a look back in history. It used to be that the U.S. government relied mainly on customs taxes for income, but that changed as a result of the enormous cost of the Civil War (1861-1865). This cost led to the creation of the first federal income tax. Initially, tax money was distributed to the states. In 1913, however, the 16th Amendment was passed giving the government the power to collect income taxes in any form without allocating funds to the states.
The government discovered that many people didn't pay the income tax, either because the exemption level was too high or because they just didn't feel like it. The government resolved the problem in 1942 by creating the Income Tax Withholding System where income tax would be paid on an ongoing basis, or pay-as-you-go. This is the same system that's in place today.
Your employer is responsible for withholding a percentage of your salary based on your:
Marital status – single or married
Number of allowances – either an exemption, credit, or other benefit you plan to claim when you file your tax return
This information is listed on your Form W-4, the Employee's Withholding Allowance Certificate. Be sure to complete the Personal Allowances, and the Deductions and Adjustments worksheets attached to the form to determine your correct withholding.
The more allowances you enter on your W-4 form, the less income tax the government withholds from your pay. This increases the amount of money you take home. It might sound as if you should claim a large number of allowances in order to take home more money each payday. However, if you don't pay enough taxes throughout the year, you may have to pay an underpayment penalty. In order to avoid paying a penalty next year, your income tax payments throughout the year must equal the lesser of:
Exceptions to the underpayment penalty are:
Your total tax due is less than $1,000
Your total tax due is less than $1,000
You had no tax liability last year
It's a good idea to be sure you don't have too much or too little tax withheld. If you have too little withheld, you'll owe money when you file your taxes. If you have too much withheld, you'll get a refund. Getting a large refund may be desirable to some, but it means you've given the government what amounts to an interest-free loan when you could have been using the money for something else during the year.
You may want to review your withholding amount when:
You had a big refund last year
You owed more money last year than you could comfortably pay
You owed a penalty last year
Your tax liability has been affected by tax law changes
You had a life or financial situation change that affects the number of exemptions you can claim – you have 10 days after the event to file a new Form W-4 with your employer
To determine your correct withholding, read IRS Publication 505, Tax Withholding and Estimated Tax and Publication 919, How Do I Adjust My Tax Withholding? Both publications are available at www.irs.gov. Complete the worksheets in each publication and compare them. If you see you should increase your withholding amount, you could:
Decrease the number of allowances
Enter an additional amount to be withheld from each paycheck
If, however, you find you should decrease your withholding amount, you could increase your number of allowances.
While your income tax is withheld, the government uses it for various things, such as:
National Defense and Security
Education (including student loans)
Health Research and Regulation
Transportation (highways, air, railroads, and mass transit)
Law Enforcement and Justice Administration
To see how your income taxes are spent by the federal government, look at thebudgetgraph.com poster Death and Taxes: A Visual Guide to Where Your Federal Tax Dollars Go.
It may be stressful to see your paycheck decreased by the amount of your withholding, but the money is used to benefit you. Review your Form W-4 each year to ensure you're withholding the correct amount for your situation. To learn more about taxes, read the related articles in our Knowledge Center Library.
*This is not intended to be, and is not tax advice. It is always wise to check with a tax professional if you have any questions before filing your taxes.
If you can't pay your federal tax liabilities promptly, here are some suggestions on how to partner with the IRS and eventually pay off your debt.
Getting an audit notice from the IRS can be intimidating. Understanding the process can help you get through it, and may even help you avoid an audit altogether.
Fees can quickly reduce your refund total for the sake of a fast-cash solution. Know the facts and consider other alternatives.
In these uncertain economic times, saving is more important than ever. But all too often, people who are trying to cut expenses end up overpaying on their taxes. In fact, as many as 2 million Americans shell out more money to Uncle Sam than they really owe every year.
Are you aware that, when you fill out your tax return, you're able to choose the tax deduction method that will save you the most money? Find out about the two methods and when each one is beneficial.
What's your debt IQ? Take one of our quizzes and find out how much you know about financial fitness.Take the Quiz Now!
Subscribe to our newsletter, packed with great articles, tips, and advice to help you make the most of your money.Subscribe Now!
Our calculators can help you figure out your budget, credit card payments, mortgage, and more!Learn More