A Complete Guide to Figuring Out Your Withholding & Form W-4

Surprises can be fun. I mean, full disclosure—I’m a typical type A personality, so they’re certainly not my thing. But I even enjoy a surprise party (for someone else, ha!), a good movie plot twist, or unexpectedly good news out of the blue.

April tax surprises, on the other hand? Absolutely no one likes those. Yet, every year about this time, I see comments like these on social media:

Social media comments about being frustrated with taxes and withholding including owing the IRS money unexpectedly, not knowing how to fill out the W-4, owing even though claiming 0.

This scenario is all too common: people get to the end of the year and cross their fingers that they won’t owe taxes. They input all their forms and answer questions using self-service tax filing software (like TurboTax). Then, they either sigh with relief or wonder confusedly what went wrong—I mean, they didn’t owe last year, so what changed?

It doesn’t have to be this way. Understanding how tax withholding works and how to fill out Form W-4 will help you confidently avoid being caught off guard by unexpected tax liabilities.

What To Do About Taxes (hint: it’s not ignoring them…)

Far too many people willingly stick their heads in the sand when it comes to learning about income taxes.

Maybe it seems too complex and overwhelming to spend the time and effort to learn about taxes. Or, maybe taxes have caused so much stress in the past that they avoid that uncomfortable feeling altogether.

Here’s the thing:

The tax law as a whole is complex and overwhelming, but your personal tax situation is likely not.

The time and effort you spend learning about taxes (and my goal is to simplify it as much as possible for you) is—without a doubt—absolutely worth the investment. And it’s likely considerably less time and effort than you think when you limit it to the tax knowledge you personally need.

The stress you’re feeling will continue indefinitely (taxes aren’t going away, my friend!) until you gain the confidence that comes from understanding taxes.

Taxes are a universal issue (or opportunity if you’re an optimist!). But the solution is simple:

  • Step 1: Learn how to calculate income taxes
  • Step 2: Learn the basics of payroll tax withholding
  • Step 3: Learn how income tax returns and payroll tax withholding intersect to determine your tax liability owed or refund due
  • Step 4: Adjust payroll tax withholding accordingly
  • Bonus step: Enjoy a relaxing April next year

Step 1: Learn How To Calculate Income Taxes

When we come down to it, the basic income tax rules are really quite simple:

  • All income you receive is taxable…unless the tax code specifies otherwise.
  • You can’t deduct anything you pay for…unless the tax code specifically allows it.

It’s the exceptions that cause complexity. The tax code is complicated because the government wants to incentivize certain behaviors, such as:

  • Saving for retirement
  • Homeownership
  • Attending college
  • Having kids (need to keep the population up to cover government spending!)
  • Charitable contributions
  • Energy conservation

That’s certainly not a bad thing, as most of these things are probably in your best interest anyway (the “having kids” one might be the most controversial, lol).

The Basic Tax Formula

If we step back from the tax forms, we can look at a basic formula for calculating your income taxes.

Going into detail about each of these items is beyond the scope of this article. However, it does provide you with a framework to be able to look at your own tax situation and determine—line by line—how your tax liability is calculated.

3 Commonly Misunderstood But Essential Tax Concepts

There are three commonly misunderstood key points that I want to point out specifically:

Key Point #1
The “total tax” in the basic tax formula above represents your federal income tax liability for the year. This is possibly the most essential point of this article: your total tax liability is not the amount due or refunded on your tax return. The total tax calculated on your return before looking at what payments have already been made (including through payroll withholding) is your tax liability, not what you end up owing or getting back when you file your return.

Key Point #2
A deduction reduces the amount of income you have to pay tax on, whereas a credit reduces your taxes dollar-for-dollar. So, a credit is significantly more valuable than a deduction.

Key Point #3
Tax rates are progressive, which means your taxable income is not all taxed at the same flat rate. Every single taxpayer gets to fill up each tax bracket from 10%, then 12%, then 22%, and so on, up to the 37% maximum rate. If you’re unsure how progressive rates work, check out my video here (start at the 25:22 mark) that illustrates how these tax “buckets” work.

Understanding taxes is essential. And I can’t emphasize this enough: you need to be able to read the actual tax forms. Otherwise, we’re back to square one, where you just answer a bunch of questions in TurboTax and blindly file whatever it spits out.

The best way to learn is to go through your own most recently filed tax return line by line. Ensure you understand where each number came from and how it was calculated.

Step 2: Learn The Basics of Payroll Tax Withholding

Now that we have a basic understanding of income taxes let’s look at how tax withholding works.

Tax withholding is a fairly simple concept. The government needs to ensure that people pay their taxes, so they require employers to withhold money and remit it directly to the IRS on the employee’s behalf.

Realistically, this is in (nearly) everyone’s best interest. This struggle is especially clear when people start their own businesses and are suddenly responsible for remitting their own income tax payments to the IRS without an employer doing it for them. In fact, most people that I see owing significant amounts in back taxes are self-employed and didn’t ensure that they set aside sufficient money to pay their taxes regularly.

The main problem with this withholding system is that most people have absolutely no idea how much they need to have withheld or how to fill out the W-4 form. As confusing as it is, the W-4 is the best way the IRS has come up with for employers to efficiently determine how much tax they should withhold for their employees.

Let’s start by looking at Form W-4 in detail.

Filling Out Form W-4 Step 1: Personal Information

The first section lists your basic personal information, social security number, and tax filing status.

Easy, peasy—you’ve totally got this!

Filling Out Form W-4 Step 2: Additional Jobs

And now, here’s where this form gets confusing (don’t worry, I’m here to help you!).

Next, the form provides different steps depending on whether you or your spouse has additional jobs that are subject to tax withholding. The amount of tax withheld will be Insufficient if you claim your dependents and deductions on multiple W-4 forms.

The only option I recommend from this list is option (a), which suggests using the IRS W4 withholding estimator. Option (b) is just a (confusing) workaround method for those who don’t wish to use the IRS’ online tool and/or don’t know how to calculate extra tax withholding on their own, and option (c) is unnecessary, as it could alert your employer that you have an additional job on the side.

We’ll return to this, but just note that understanding the basics of income taxes will come in handy here. If you only have one job (including you and your spouse, if applicable), you can simply ignore this section of the form.

Filling Out Form W-4 Step 3: Claiming Dependents

As noted in the previous section of the form, only dependents eligible for either the child tax credit or credit for other dependents should be listed on one W-4 form (for all jobs) between you and your spouse.

This part is fairly self-explanatory. If you’re under the income limits ($200,000 if single/head of household or $400,000 if married filing jointly), simply multiply the applicable amounts based on whether your dependents qualify for the child tax credit (under 17 at the end of the tax year) or credit for other dependents (all other dependents).

Perhaps you’re not sure whether you’re under the income limit or whether you’re otherwise eligible to take these credits. This is a good opportunity to look at your prior year’s tax return and learn more about how your income taxes were calculated.

Filling Out Form W-4 Step 4: Other Adjustments

The “other income” and “deductions” lines only need to be filled out once between all jobs (including for a spouse), similar to claiming dependents in the previous section.

This section allows you to adjust tax withholding (increase or decrease) if you have either taxable income not subject to other withholding or deductions above and beyond the standard deduction.

When there are scenarios in which people owe taxes and aren’t sure why, it’s often due to additional income for which taxes aren’t already being withheld during the year. Some examples include:

  • Investment income (i.e. interest, dividends, capital gains)
  • Retirement income (i.e. pensions, IRA distributions, taxable social security)
  • Business income (i.e. self-employment income, passthrough income)
  • Rental real estate income

Including additional deductions isn’t as critical; the result will simply be more taxes withheld than necessary. However, if your itemized deductions are significantly higher each year than the standard deduction, you will want to include the difference on this line of the W-4.

In addition to excess itemized deductions, you can also include other above-the-line deductions, such as IRA contributions and student loan interest.

In this adjustments section, you can also add an additional “extra withholding” amount per pay period. For those who understand income taxes, this is often the most useful box on the form.

How Your Employer Uses Form W-4

Your employer applies the information on this form to a fixed payroll calculation that tells them how much to withhold each pay period in federal income taxes. These payments are then directly paid to the IRS on your behalf.

Step 3: Learn How Income Tax Returns and Withholding Taxes Intersect

We’ve looked at how to calculate your taxes and gone through the basics of employer income tax withholding, as well as how to fill out form W-4 (notably understanding that employers do not withhold an arbitrary amount – it’s literally from information you have provided them!).

Let’s now look at how income tax returns and withholding are related.

At the end of the year, your employer files a form W-2 for each employee. This form reports to the IRS how much money you made (taxable income), how much you had withheld in federal income taxes, and other informational items (such as retirement and HSA contributions, health premiums, etc).

This W-2 form is a summary of the totals of all of these items on your paystubs throughout the year (although there are some exceptions for certain income items that are commonly added at the end of the year).

You then use the W-2 form—along with many other tax forms—to prepare your tax returns (generally Form 1040 and accompanying schedules).

If you have other sources of income, itemize your deductions, or have any other complexity at all in your tax situation other than your income from this one job (which nearly everyone does), the amount of income taxes withheld from your employer(s) will not exactly match your total tax on your tax return.

The tax return is simply a reconciliation between your tax liability for the year and what you have already paid to the IRS. Your refund or amount due after filing the forms is not the most notable amount. It it simply a number that reflects whether you overpaid (yay, a refund!) or underpaid (bummer, taxes due!) your taxes.

Step 4: Adjust Your Payroll Tax Withholding

You should now understand why you may have a mismatch between your actual tax liability and what you’ve paying in throughout the year.

To reconcile these amounts (and avoid unhappy tax surprises), we’ll need to estimate our actual tax liability for the year and make adjustments to the Form W-4 to better match withholding with that expected liability.

I recommend using the IRS’ tax withholding estimator, as it will assist you in calculating your total income tax liability for the year, how much you’ll have withheld in total by the end of the year based on your most recent paystub information, and even provide you with exactly how to enter information on Form W-4 to provide to your employer. If you have multiple jobs (even between multiple spouses), it will provide separate W-4 forms for each.

With this tool, like any financial tool, the outputs are only as good as the inputs you provide. This is why it’s so essential to understand your own tax situation and tax forms.

Don’t forget to revisit your withholding at the beginning of each year, especially if you’ve made mid-year changes to catch up on tax withholding. And, any time you experience a significant life change (such as getting married, having a baby, etc.), you should recalculate your expected taxes and adjust your withholding then as well.

Example: Jane & John Doe’s Withholding Calculation

Let’s go through a quick example of some of the steps we’ve discussed above. Jane & John Doe have a simple tax profile that includes the following:

  • Married filing joint tax status
  • Jane makes $100,000 gross/year through her full-time employment
  • Tax-related payroll deductions include $10,000 in medical insurance premiums and $5,000 in 401k contributions
  • John is currently a stay-at-home parent
  • The couple has two young kids (those cute little dependents, awww!)
  • Minimal income outside of employment income ($250 in interest income)
  • They will take the standard deduction

Following the steps listed above, we can take a look at whether their current W-4 withholding is sufficient.

Step 1: Calculate tax liability using the income tax formula

Total income for the Doe family is calculated as follows: $100,000 gross income – $10,000 medical insurance premiums – $5,000 retirement contributions + $250 interest income.

Shown in the chart below is the income tax calculation for Jane & John Doe.

Step 2: Determine total annual income tax withholding

Jane filled out her W-4 based on the basic assumptions that she is married filing joint tax status, has two dependents eligible for the tax credit and will take the standard deduction.

Her biweekly paychecks will reflect withholding of $85.85, as shown in the example paystub below.

At the end of the year, Jane will receive a W-2 form that reflects her taxable income and total income taxes withheld (note that the total withholding shown reflects $85.85/paycheck x 26 paychecks/year).

Step 3: Reconciliation of Income Taxes & Withholding Example

Now, we can then reconcile how much this couple owes or will get as a refund based on what they’ve already paid to the IRS throughout the year:

  • Total tax = $2,262 (from step 1)
  • Less: $2,232 federal tax withheld (per W-2 on step 2)
  • Total tax still owed = $30

Whether this couple would be happy or not owing a small amount of tax when they file their tax return depends on their understanding of taxes. If this couple doesn’t understand how their taxes were calculated, they may be upset that they owe money instead of getting a refund. Or, if they do understand taxes, they may have intentionally minimized their refund so that they could utilize the money for savings goals throughout the year.

Of course, this covered a very straightforward and simple tax situation. Those with high enough incomes to encounter tax phaseouts or who have rental properties, businesses, trusts, etc., are subject to additional rules and extra tax calculations that add significant complexity.

Final Thoughts

While it may be tempting to view your tax refund or tax due as the defining figure of your tax liability, it’s essential to understand that these amounts are merely a reconciliation between actual tax liability and amounts you’ve already paid throughout the year.

By learning more about income taxes, you can improve your financial life, reduce stress and enjoy your annual spring break without worrying about any surprise tax liability waiting for you on the other side of it.

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welcome!

I’m Kathryn Hanna-wife, mother of 3 and a Certified Public Accountant. I love to budget (really, I do!) , build spreadsheets and spend money on travel, sewing supplies and good chocolate.

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