The first step in planning for the year’s tax liability is filling out a W-4 form for your employer. Most people do not even know what a W-4 is let alone how to fill one out or the consequences for completing it incorrectly. While you will not be stoned in the street for claiming too few exemptions, you may end up losing valuable tax dollars.
The W-4 form is the one you complete for your employer when you begin working. You are also supposed to fill out a new one at the beginning of each year, but some companies may not comply with this requirement. So, in the mountain of paperwork you fill out for your employer, which one is the W-4? It is the one that asks you how many exemptions you want to claim for the year and determines how much money is withheld from your salary for tax purposes.
There are two strategies people generally use in filling out their W-4. The first is claiming excessive exemptions to avoid taxes being withheld and risking having to pay in. The second is not claiming any or few exemptions to get a larger refund at tax time. However, there are flaws in each of these approaches. Technically, there is a third option which involves just guessing, which should be avoided.
Too many exemptions
The flaw with this tactic is the risk of having to pay in when you file your tax return. While most financial advisors will suggest claiming as many exemptions as possible to avoid too much in taxes being withheld, unless you have adequate deductions and credits, you risk not paying enough in and owing later.
Too few exemptions
The other extreme is claiming no or too few exemptions to ensure a tax refund. The problem with this is that you pay in too much in taxes throughout the year. So, you are needlessly paying Uncle Sam for money that is not owed. This is actually what a refund is most of time – sending money back to you that you overpaid. However, there are certain credits designed to provide an additional tax refund for certain circumstances.
The key to filling out your W-4 is finding the balance between too many and too few exemptions. To do this, the instructions provide amazing clarity. You may be hesitant to actually read the instructions when you are starting a new job, but at least being familiar with the form will allow accurate completion. Perhaps looking at form W-4 at the IRS website before starting a new job would be a good way to take your time and calculate the number of exemptions you should claim.
Basically, when you are filling in a W-4, you are prompted to enter the number of exemptions you are entitled to based on the number of dependents you have, certain credits you may claim, and deductions you qualify for. Your spouse’s employment status is also a factor accounted for.
