by Victoria 

Form W-4: Withholding too much, too little or just enough?


I'm Victoria! 

With 14 years of working with countless clients, I'm on a mission to empower women and millennial's to take control of their finances, build wealth confidence, and achieve financial independence. 

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written by: victoria mcgruder, cpa, cpwa®

Form W-4 is an IRS form, Employee’s Withholding Certificate, that employers use to calculate payroll taxes and send the taxes to the IRS and certain states on behalf of their employees.

If you are an employee of a company and filled out Form W-4 at the start of your employment, then you are having taxes withheld from your pay as a result. But no one really gives you a step by step guide as to what the numbers really mean on the form and how the form will ultimately impact you and your tax bill.

So my goal in writing this post is to educate you a bit on withholding, identify how you are impacted as a result of the way you fill out your Form W-4 and go through some of the pros and cons of withholding too much or too little.

What is Form W-4?

Employers use this form along with the tax withholding tables provided by the IRS to determine how much income tax to withhold from your paycheck.

The W-4 form considers the number of dependents you have in your household, your filing status, the income you generate and whether you’re claiming the standard or itemized deductions on your tax return.

The W-4 changed in 2020 and did away with claiming personal exemptions to reduce your tax withholding. The IRS revamped the form a bit and now in order to reduce your tax withholding you are required to claim dependents or utilize the corresponding deductions worksheet that comes with the form.

So here’s a little breakdown:

If you want to withhold more taxes on your paycheck…

  1. You can file single or married filing separately
  2. Claim less dependents or deductions
  3. Add an extra amount to withhold on Step 4, Line C

If you want to withhold less taxes on your paycheck…

  1. Claim all of your dependents
  2. In step 4, line b, utilize the Deductions Worksheet to identify your additional deductions that you will be applying to your tax return.

If you are hoping to breakeven come tax time and owe as close to zero as possible to the IRS…

  1. It will be incredibly important to accurately report your correct filing status, amount of dependents, the other sources of income generated for the household and the deductions that you anticipate being available to you come tax filing time. This will provide the W-4 form a more realistic view of your tax situation and will withhold taxes accordingly.
  2. I would also suggest utilizing the IRS’ Tax Withholding Calculator which is a great tool in identifying how much withholding to take out for your specific circumstances.

It Works as Simply As This

If you claim all your dependents and deductions on Form W-4, then less withholding taxes will be taken out of your pay. You will then take home more money with each paycheck. But come tax time and when you file your tax return, if you withheld too little, you run the risk of having a tax bill.

Tax due is a result of paying too little taxes through your withholding or otherwise throughout the year.

If you opt to claim Single with no dependents or deductions, despite your marriage status and dependents, you will have significantly more withholding taxes taken out of your pay. You will then take home less money with each paycheck. Come tax time, if you withheld too much, you’ve given the IRS more money than required and will result in a tax refund.

Tax refunds are a return of the money you overpaid in taxes during the prior year.

The Bottom Line That Many People Do Not Understand…

Your tax liability will be the SAME despite how you choose to withhold your taxes. It is just a matter of WHEN you pay the tax. Throughout the year in your withholding, when your tax return is due, or a combination of both. It is the SAME tax liability dependent on your income, filing status, deductions, credits, etc. (excluding penalties).

Why is a Big Tax Refund Viewed as a Negative Outcome for Some?

Getting a large tax refund is the result of withholding too much throughout the year. People refer to this as an interest free loan to the IRS – you’ve given the IRS more than required instead of keeping that money for yourself throughout the year.

The biggest negative of a Large Tax Refund Is this…

You withheld too much throughout the year meaning that money that could have been in your pocket each and every paycheck instead of going to the IRS. You could have been taking that extra money each month and investing it or paying down debt to better position you for financial success.

So if you are one of those individuals who receives a significant tax refund and says you will invest your refund or pay off your debts that have accumulated when you receive it come tax time, then yes my suggestion would be to consider the following:

  1. Withhold less and contribute more to your Pre-Tax 401K

    • This will both drive down your taxable income and also allow you to be investing more at the same time.

  2. Withhold less and invest more throughout the year

    • If you have maxed out your 401K or do not have a employer provided retirement plan to contribute to, then I would suggest withholding less and taking that money each month to invest as opposed to waiting until April of the following year to invest a lump sum.

  3. Withhold less and pay off high interest bearing debt on a more consistent basis

    **Withhold less meaning, less than you currently are, but still enough to avoid having a significant tax bill come tax time.**

HOWEVER, if you do not plan to invest or payoff debt with that tax refund and you are maxing out your retirement plans or contributing as much as you feel comfortable with throughout the year and have no debt – then withholding more and receiving a significant tax refund could be a great alternative savings account.

I View my Tax Refund as A Short Term Savings Account

Here’s the thing – I understand the consequences around withholding more and having less for myself each paycheck. But let’s not forget, personal finance is personal. I enjoy getting a large refund for three reasons:

  1. I do not invest my refund and I do not have significant debt. I already invest elsewhere throughout the year and am maxing out other retirement options. I also prefer not to invest large sums of money all at once and enjoy having a system in place where I invest monthly.
  2. I like learning to live on less
  3. I like the automation of savings that has been created for me for short term goals without having the ability to dip into it.

So sure, I could have been getting more money each paycheck and transferring that to a savings account. Ok, I missed out on $50 of interest from the bank. But you know what else I missed out on, the opportunity to take it out to spend on something else that wasn’t part of my short term goals or needs. The money wasn’t there and deposited into my account, I was not tempted to spend it elsewhere.

That is how I have created a discipline for short term savings – through the automation of my withholding.

Examples of short term goals could be – home improvements or renovations, travel and vacation plans, replenishing your peace of mind account or using it as a means to budget out the next 6-12 months.

So long as short term savings rates are at laughably low numbers, I will continue to plan to use my refund for short term savings goals.

Revisiting Your Withholding

There are a few times in your life that you may want to consider revisiting your withholding as a result of a life changing event that will have an impact on your taxes.

  1. Birth of a new child or new dependent
  2. A marriage or divorce throughout the year
  3. Having multiples streams of income or multiple jobs
  4. A significant change in income for you and or your family
  5. You purchased a home

    So if any of the above will be happening for you in 2022, and you have an interest in adjusting your withholding’s, do it now at the beginning of the year so your changes will be reflected for the whole year!

Hope you found this helpful in identifying why you may opt to choose one option vs another and to determine what works best for you and/or your family.

Tune in to more blog posts every Tuesday and Thursday!

Follow @finpoweredfemale for more personal finance, tax, investing and business ownership tips on building wealth with confidence!

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Thank you for being here - I'm Victoria!

I'm a financial advocate, coach, and blogger on a mission to help you build wealth with confidence! 

Having worked closely with countless clients over my 14 year career, I've gained a very deep understanding of money management and effective planning strategies in guiding individuals and families towards financial success. Now, I want to share that wealth of knowledge and insight to empower YOU to take control of their finances, make well-informed decisions, and create a life of abundance without the stress of finances looming over you. I'm so glad you're here! 

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