PILLA TALKS TAXES - Featured Article
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COMPLETING FORM W-4, EMPLOYEES WITHHOLDING

ALLOWANCE CERTIFICATE

How Hard Can It Be?

by Daniel J Pilla  

The 2019 filing season brought into sharp focus—much more so than in past years—just how few Americans understand how to complete Form W-4, Employees Withholding Allowance Certificate. For example, the news media was apoplectic over reports in February showing that tax refunds were down about 9% over last year’s numbers. A hysterical cry went out that such data was proof that the Tax Cuts and Jobs Act was nothing more than tax cuts for the rich. After all, if your refund is down, it must mean your tax hit went up.

There were a number of problems with these reports. For starters, only about 25 million individual tax returns, out of the expected 152 million, were filed by the time the reports were issued. Thus, the sample size of returns was too small to draw any firm conclusions. Most notably, however, was the fact that effective January 2018 (one year before the filing season began) the IRS changed the withholding tables to reflect the fact that most taxpayers would in fact pay less tax in 2018 than they did in prior years because of the Jobs Act. Said another way, people were getting their tax refunds every month in their pay checks rather than at the end of the year.

Finally, by the time we were at the high tide of filing season and well over 100 million returns were filed, it came to light that the average tax refund was actually up a few points over last year. There was no corresponding celebration by the media to acknowledge that the Jobs Act indeed did cut taxes for most citizens.

In the background of this discussion is a point that I’ve been making for years: people either don’t pay attention to filling out their Form W-4, or they just don’t know how to do it. I rather believe more of the latter element drives the issue. In light of the firestorm of controversy, the IRS redesigned Form W-4 so people might more accurately set their withholding. Now there’s backlash over whether the IRS created a document that, like just about every other tax form, is way too complicated for the average person to read, comprehend and complete.

My response is that this just isn’t that complicated.

Understanding Exemptions and Allowances

Let’s start with understanding the very basics of the form. It is titled (and has been for decades), Employees Withholding Allowance Certificate. It calls for the citizen to inform his employer of the number of withholding allowances he wishes to claim for withholding purposes. The fewer allowances claimed, the more money is withheld. The opposite is also true. The greater the allowances claimed, the less is taken.

Likewise, a person declares on the form his tax return filing status, whether single, married (filing jointly or separately), or head of household. Your tax return filing status impacts whether more or less is taken. For example, if you are a single person with one withholding allowance, more will be withheld than if you are married filing jointly with one allowance. That is a function of the different tax tables that apply to the various filing categories.

Suppose you are married with two children. Prior to the Jobs Act, you were entitled to claim an exemption on your tax return for yourself and each dependent. Thus, in this example, you would get four exemptions on your tax return. These exemptions operated to reduce your tax liability because each exemption reduced taxable income by about $4,500. Since most people believe that exemptions and allowances are the same thing, they claimed only four allowances on their W-4. Because this misunderstanding caused over withholding, about 80% of all taxpayers overpaid their taxes, leading to a refund of about $3,000, on which the IRS paid no interest whatsoever.

But as I said, allowances and exemptions are not the same thing. An allowance is defined as any tax return item that reduces your tax liability. That certainly includes exemptions but is by no means limited to them. For example, standard or itemized deductions also reduce your tax liability. So do tax credits and retirement fund contributions. All of these (and more) need to be included in calculating allowances. I explain this further below.

IRS Redesigns the W-4

In the wake of the confusion and controversy of the 2019 filing season, the IRS redesigned Form W-4. Actually, it’s not the form so much as the worksheet that goes with the form that was redesigned. In my opinion, it’s for the better. The worksheet more clearly walks the reader through the process of figuring allowances. The new design is intended to get people closer to their ideal withholding amount so their withholding better matches their tax debt. That is to say, they do not over-withhold and thus und up with a big refund (and no interest); nor do they under-withhold and (worse) end up with an unfunded surprise tax debt they can’t pay.

A Walk Through the Form 

This is part of an article from the May 2019 issue of Pilla Talks Taxes Newsletter. Subscribers to Pilla Talks Taxes are able to read complete articles as well as the rest of the newsletter when they log into their subscription account on their non mobile device. http://taxhelponline.com/subscriber-login.html