What Tax Professionals Need to Know About the New IRS Form W-4
The latest IRS Form W-4 (Employee’s Withholding Certificate) is all new for 2020. Employees use the W-4 to adjust their payroll withholding so that it’s close to their actual full-year income tax liability.
The new Form W-4 is not well-understood and tax pros often didn’t get many questions or advise clients on how to complete it. That may now have changed.
Here’s what you need to know, and how to advise clients to avoid possible mishaps:
First, the new form is not required for existing employees. Employers will continue to observe the existing withholding allowances and filing status elected by employees. But for those hired after 2019, and anyone who wants to adjust their withholding, the 2020 version is the only valid Form W-4.
Although the form may be daunting to those who see it for the first time, it’s really much simpler. However, folks may need details from last year’s tax return.
What’s changed exactly? First, there are no withholding allowances. Allowances have always been the basis for adjustments and the only way to reduce withholding.
There is also no dedicated area to claim exemption from withholding. (It can still be claimed – more on that later)
There are many new inputs:
• New filing status - Head of Household
• Adjustment for multiple jobs and two-earner families
• Full-year child and dependent tax credits
• Full-year other (non-wage) income
• Full-year deductions (over the standard deduction amount)
The only entry that did not change is the per-payroll additional amount to withhold. More on these below, including pitfalls to avoid.
Adjustment for Multiple Jobs and Two-Earner Families
Step 2 is the adjustment for multiple jobs and families in which both spouses work. This is how to get the right tax rates for the family’s combined income (household for tax purposes) when the employer only knows about the one income source (i.e., wages) of one family member.
There’s a new Checkbox, which is very easy for spouses that earn about the same amount. The IRS reduced the previous 9-step worksheet and two table lookups to a single checkbox.
If checked, the tax tables divide the standard deduction and tax brackets equally between two jobs. Tax rates apply at roughly half of the income threshold (e.g., the 24 percent rate normally applies for wages over $180K, but If the Step 2 box is checked, the 24 percent rate applies to wages over about $96K).
If the Step 2 box is checked for families with two wage-earners, BOTH spouses should check the box, but ONLY ONE should complete Steps 3 through 4(b). For example, in a family with two young children, the household may have a child tax credit of $4,000.
If both spouses claim the full child tax credit in step three of the Form W-4, both spouses would have their withholding reduced by $4,000 (i.e., $8,000 total). They would then owe the IRS $4,000 on their annual income tax return.
If there are significant differences in the spouses’ income or more than two jobs, there’s also the familiar worksheet attached to Form W-4, or an improved IRS online withholding estimator (www.irs.gov/w4app).
The new form has lined for the following adjustments:
• Child and dependent tax credits
• Other income
• Per-payroll additional amount to withhold
This is another area in which the W-4 is much simpler for employees. Previously all adjustments had to be converted into allowances (which reduce taxable wages) or additional amounts to withhold. Now, employees can just enter the full-year dollar value of any tax credits, other income and deductions over the standard deduction amount.
On line 4a (Other Income), employees will be able to enter estimated full-year non-wage income not subject to withholding (such as rental income, interest and dividends). Previously, employees with other income sources completed a worksheet to estimate an additional amount to withhold each pay period. Entering other income on Form W-4 can make it unnecessary to make quarterly estimated payments or face possible penalties.
Caveat: Line 4a does not address self-employment tax. Taxpayers with a mix of W-2s and 1099s (i.e., work as an independent contractor) should use the IRS online withholding estimator (www.irs.gov/w4app) or see Publication 505, Tax Withholding and Estimated Tax.
Line 4(b): Deductions
In the Form, Line 4(b) permits employees to enter estimated full-year dollar amount of deductions over the standard deduction amount (e.g., state/local taxes up to $10,000; mortgage interest, charitable contributions…).
Caution: Employees are referred to the worksheet on page 3. Don’t skip this step! Form W-4 asks for “deductions other than the standard deduction.” Be sure to enter expected deductions over the standard deduction amount. For example, a Married Filing Jointly family with expected total deductions of $34,800 in 2020 should enter $10,000 on line 4(b) - - [$34,800 minus the standard deduction of $24,800 in 2020] - - rather than total deductions.
Line 4(c) Extra withholding. “Enter any additional tax you want withheld each pay period.” This is another option by which employees can adjust for multiple wage-earners in the family, or a second job, or other income. Line 4c is the only entry that asks for a per-payroll amount. All other entries are full-year amounts.
Steps 2, 3 and 4 are optional. Employees who prefer not to modify their withholding will be able to enter only their name, Social Security Number, address and filing status, and sign and date the form. If someone doesn’t have access to their last-year’s tax return, for example, they can complete these lines later.
Claiming Exemption from Withholding
Although the dedicated area to claim exemption from withholding was removed, it can still be claimed if a taxpayer both
- owed no federal tax in 2019
- expects to owe no federal income tax in 2020
The instructions explain how, and note that “If you claim exemption, you will have no income tax withheld from your paycheck and may owe taxes and penalties when you file your 2020 tax return.”
Tax professionals may want to warn clients about against claiming exempt. The tax tables automatically calculate zero income tax for lower-income situations, with the exception of those that only work for a short time each year (i.e., seasonal workers).
Tax tables assume that each person works year-round and the current wage amount is the same through the year. Even for seasonal workers considering claiming exempt, consideration should be given to the household’s full-year income.
Pete Isberg is responsible for managing legislative and regulatory affairs for ADP, covering a variety of employer compliance matters including employment tax payments and major legislative trends such as the Affordable Care Act. Pete has over 30 years of experience working with state legislatures and Congress, as well as the IRS and state...