26 Oct W-4 Form: Where Is Your Money Going?

Understanding Your W-4: Protect Your Cash Flow Year-Round

By Gerry Toro, CEO of Optimum Business Services

Most of us look at our paycheck and focus on one number: what actually made it into the bank account.

But understanding what is being withheld from your pay is important, especially when it comes to federal income taxes.

Your Form W-4 plays an important role in determining how much federal income tax your employer takes out of each paycheck. If the information on that form no longer reflects your current situation, you may be having too much tax withheld—or not enough.

The important thing is not to wait until tax season to find out.

What Does a W-4 Actually Do?

Form W-4, the Employee’s Withholding Certificate, gives your employer information used to calculate your federal income tax withholding.

It does not control every deduction you see on your paycheck. Social Security, Medicare, health insurance, retirement contributions and other deductions are separate.

The W-4 specifically deals with federal income tax withholding.

Many people complete the form when they begin a new job and then never think about it again. But your financial situation can change considerably over time.

A new job, a second job, marriage, divorce, children, a working spouse or additional income can all affect whether the amount being withheld is still appropriate.

Multiple Jobs Can Create a Surprise

This is one of the most common situations I see.

Suppose you have one full-time job and then take a second job in the evenings or on weekends.

Each employer generally calculates withholding based on the wages it pays you and the information you provide on your W-4. The problem is that your final tax return looks at your overall income.

The same issue can happen when both spouses work.

If your W-4 does not properly take the additional income into account, the total amount being withheld during the year may not be enough.

That does not automatically mean you will owe taxes, but it can create an unexpected balance when the return is filed.

What About a Side Gig?

This is another area people sometimes overlook.

Maybe you have a regular job but also:

• Drive for Uber or Lyft
• Deliver food
• Do consulting work
• Perform home repairs
• Sell products online
• Provide beauty, cleaning or other services
• Operate a small business on the side

Your regular employer normally does not know about that additional income.

And unlike a regular paycheck, taxes may not automatically be withheld from your side income.

Depending on the type of work, you may also be responsible for self-employment tax in addition to regular income tax.

That is why someone can have taxes coming out of every paycheck and still owe money when the tax return is prepared.

In some situations, additional withholding from your regular paycheck can help cover the tax related to outside income. In other cases, estimated tax payments may be appropriate.

The important thing is to look at the complete picture.

Life Changes Can Affect Your Withholding

Your W-4 should also be reviewed when something significant changes.

For example:

• You get married or divorced.
• You or your spouse start or stop working.
• You have or adopt a child.
• You begin working a second job.
• Your income increases significantly.
• You begin earning income from a side business.
• Your deductions or credits change.

These events can affect your overall tax situation.

That does not mean you need to change your W-4 every time something happens. It simply means it is worth reviewing.

Is a Big Refund Always a Good Thing?

People sometimes intentionally have extra money withheld because they enjoy receiving a larger refund at tax time.

There is nothing necessarily wrong with that.

For some people, it acts almost like forced savings.

But it is important to understand the trade-off.

If substantially more tax is being withheld than necessary, you have less money available in your paycheck throughout the year.

That might be money you could otherwise use for household expenses, savings, paying down debt or other financial priorities.

On the other hand, having too little withheld can leave you with an unexpected tax bill.

The goal is not necessarily to receive the largest refund possible or to owe exactly zero.

The goal is to have your withholding reasonably aligned with your expected tax liability so that there are no major surprises.

Don’t Wait Until Tax Season

One of the best things you can do is review your withholding during the year.

The IRS provides a free online Tax Withholding Estimator that can help you determine whether your current withholding appears appropriate.

Before using it, it helps to have:

• Your most recent paystubs
• Your spouse’s paystubs, if applicable
• Information about other income
• Your most recently filed tax return

The estimator can help you determine whether you may want to submit a new W-4 to your employer.

And remember: submitting a new W-4 does not change your tax return itself. It simply changes how much federal income tax is withheld from future paychecks.

The Bottom Line

Taxes should not be something you discover once a year when your return is prepared.

If you have more than one job, your spouse works, you have a side business, or your financial situation has changed, take a few minutes to review your withholding.

A little planning during the year can make a major difference in avoiding surprises later.

At Optimum Business Services, we help individuals and business owners understand their tax situation in plain language and make informed decisions throughout the year—not just during tax season.

If you have questions about your W-4, multiple jobs, side income or whether your current withholding makes sense, contact us at 773-257-0911.