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Wage Withholdings and the W-4 Options for 2021

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The first step in helping your clients better understand wage withholdings is resolving whether payments for services are being made to a contractor or employee (See “Understanding Employee vs. Contractor Designation,” FS-2017-09, July 20, 2017). The salary withholdings roadmap begins with the 2020 IRS Form W-4, “Employee’s Withholding Certificate,” and instructions found in IRS Publication 15-T “Federal Income Tax Withholding Methods.” (See generally “Topic No. 753 Form W-4 – Employee’s Withholding Certificate,” IRS.gov, https://www.irs.gov/taxtopics/tc753).   

Dec 9th 2020
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The redesigned Form W-4 of 2020 no longer uses allowances and instead accommodates head of household situations. Moreover, there is a do-nothing approach if employment arose before 2020. These employees have the option of staying with their existing withholding instructions on the pre-2020 Form W-4.  

Individuals beginning employment in 2020 would fill out the current Form W-4. Those clients beginning employment pre-2020, but wanting to adjust their withholding, would need to use the new form (“FAQs on the 2020 Form W-4,” #18, irs.gov, https://www.irs.gov/newsroom/faqs-on-the-2020-form-w-4).If the employee has no W-4, the employer is to withhold the maximum. 

The overall context of the revised form is one of added complications arising with the 2017 Tax Cuts and Jobs Act (See also final regulations T.D. 9924, 10/6/20, with commentary: https://public-inspection.federalregister.gov/2020-22071.pdf).

Following is the basic design of the 2020 Form W-4: 

  • Filing status (Step 1; single, married filing joint return, or other)
  • Multiple jobs or spouse works (Step 2)
  • Claiming dependents (Step 3)
  • Other income, such as interest income
  • Other deductions, such as itemized mortgage interest expense (Step 4)
  • Signing (Step 5)

The form is basically instructions for the employer who will in turn use the information to compute withholdings.   When the form is required, only Steps 1 and 5 are absolutely necessary. The steps are relatively simple except Steps 2 and 4.

Step 2 has options (a), (b) and (c), only one of which is to be used. Step 2(a) leads the employee to an IRS computational site: www.irs.gov/W4App. If the individual owes alternative minimum tax, certain other taxes, or has long-term capital gains or qualified dividends, the site encourages using the help of IRS Pub. 505.

The latter types of income are taxable but the effective tax rate on such income may be less than would be the case with ordinary income. Step 2(a) professes to encompass step 2(b) dealing with multiple jobs or 2(c) which can be used if there are two jobs with similar pay. Within the basic W4App is a useful Tax Withholding Estimator (“Tax Withholding Estimator,” IRS.gov, https://www.irs.gov/individuals/tax-withholding-estimator).

The three options under Step 2 “involve tradeoffs between accuracy, privacy and ease of use….” (“FAQs on the 2020 Form W-4, #11, irs.gov, https://www.irs.gov/newsroom/faqs-on-the-2020-form-w-4). For example, Step 2(b) may be the choice if one doesn’t have access to the Tax Withholding Estimator. If you want to have “roughly accurate withholding and retain privacy, you may want to use the Multiple Jobs Worksheet on page 3.”

If one has self-employment income and self-employment tax, it is possible to incorporate these into the withholding computations rather than making separate estimated tax payments.

“If you have income from self-employment (including as an independent contractor), you will generally owe both income tax and self-employment tax. Form W-4 is primarily intended to be used by employees who are not subject to self-employment tax. Thus, like the old Form W-4, the redesigned Form W-4 does not compute self-employment tax. If clients would like to use Form W-4 to make an adjustment to withholding to account for self-employment income that they will receive from another source, use the Tax Withholding Estimator at www.irs.gov/W4app or refer to IRS Publication 505.” (“FAQs on the Form 2020 Form W-4,” Question 13; https://www.irs.gov/newsroom/faqs-on-the-2020-form-w-4).

The Tax Withholding Estimator is encouraged if your client:

• expects to work only part of the year (this does not apply if you are only switching jobs),

• had a large balance due or refund last year and it is no longer the beginning of the current year,

• have dividend or capital gain income or are subject to additional taxes, such as the additional Medicare tax

• have self-employment income

• prefer the most accurate withholding for multiple job situations, or

• prefer to limit information provided in Steps 2–4 but do not want to sacrifice accuracy (“FAQs on the Form 2020 Form W-4, Question 15; https://www.irs.gov/newsroom/faqs-on-the-2020-form-w-4).

In general, the withholding estimator focuses on income tax, not FICA, although it can encompass the additional Medicare tax that applies in certain high earned income situations (See “Tax Withholding Estimator FAQs, Do my estimated results include FICA and Medicare tax?,” IRS.gov, https://www.irs.gov/individuals/tax-withholding-estimator-faqs). 

The enhanced procedures of the IRS in the revised Form W-4 and the Tax Withholding Estimator should generally improve the accuracy of wage withholdings.

             

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