Learn more at this time about W-4 withholdings and how you can maximize your tax position…
Caution: 15 minute read
As the new year and tax season advances, many have questions or concerns about their federal (and state) tax withholdings, and they want to know how they can more effectively manage those withholdings.
And with TheWealthIncreaser.com blog being down for 5 days (March 12th to March 17th) for the first time since creation (01/2014) due to domain hosting and server issues (sincere apologies to all), this discussion takes on more meaning than most, and it is the desire of TheWealthIncreaser.com that you will sincerely build wealth more effectively as a result of visiting this post.
In this discussion TheWealthIncreaser.com will address how withholdings on income earned in the United States occur, so that you–or those whom you know can utilize the system to achieve more.
W-4 Employee’s Withholding Certificate
Your employer provides you the opportunity to elect withholding for income tax purposes upon hire, or upon request by you if you are a current employee. That opportunity could allow you the chance to adjust withholding amounts by changing certain elections and/or having additional amounts withheld.
By adjusting your withholding amounts, you can get to a point where you have a designated amount withheld so that you can get a refund or owe–or increase the amount of the refund or amount that you will owe the IRS. Your withholding for the year would be displayed on your form W-2 that you get at tax time from your employer (usually in January or February).
Before 2020, you had to claim a certain number of withholding allowances on form W-4 (you could also pick zero). The amount of federal income tax withheld from your paycheck was then based on how many allowances you claimed. The more allowances that you claimed, the less the IRS would withhold. Prior to the change you could claim fewer allowances than what you were entitled to if you wanted to increase your withholding, but you couldn’t claim more allowances.
Allowances are no longer allowed on the new form that went into effect in 2020!
Generally, upon hire you would complete Form W-4 so that your employer could withhold the correct federal income tax from your pay based on what you desire. If changes are needed, you can complete a new Form W-4 each year and particularly when your personal or financial situation changes. Depending on the size of your employer, the process would be done through your Human Resources or Payroll department–or if a small operation through your manager or other designated individual(s).
Key factors since the arrival of the new form now include:
Step 1: personal information (name, address, SSN) and Single, MFJ, or HOH election
Step 2: multiple jobs or spouse works election
Step 3: the number of qualifying children under age 17 multiplied by $2,000 and the number of dependents multiplied by $500 can be entered based on the amount calculated–and if you plan on being eligible for other credits, the estimated amount can also be entered
Step 4: other income, deductions and extra withholdings (key step for adjustment from your current withholding), and additionally if you expect to have other income such as interest, dividends, retirement income and/or you expect to itemize–you can include extra withholdings based on your own situation
Step 5: you would sign and date
The IRS now offers a tax estimator that many find helpful when deciding on their withholding amounts.
If you are self employed or have W-2 income you can elect to pay estimated taxes and if you choose this option, payments are expected to be paid to the IRS based on your income at intervals of April 15, June 15, September 15 and January 15 of the new year through the EFTPS (you set up online and in a week or so you will receive correspondence in the mail that allows you to finalize setup and start making payments) system or other arrangement that you can set up with the IRS that would allow you to make timely payments.
Once your account is set up securely through the EFTPS system you can make payment for the current interval and also schedule payments for up to 3 additional intervals based on the payment date(s) that you select (be sure your account is adequately funded on the dates that you elect to pay), thereby ensuring that you avoid underpayment penalties if your estimate of taxes you owe is accurate or fairly accurate.
Individuals, including sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.
Corporations generally have to make estimated tax payments if they expect to owe tax of $500 or more when their return is filed.
You may have to pay estimated tax for the current year if your tax was more than zero in the prior year. See the worksheet in Form 1040-ES, Estimated Tax for Individuals for more details on who must pay estimated tax.
You don’t have to pay estimated tax for the current year if you meet all three of the following conditions.
- You had no tax liability for the prior year
- You were a U.S. citizen or resident alien for the whole year
- Your prior tax year covered a 12-month period
You had no tax liability for the prior year if your total tax was zero or you didn’t have to file an income tax return!
For additional information on how to figure your estimated tax, refer to Publication 505, Tax Withholding and Estimated Tax.
To figure your estimated tax, you must figure your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year.
Estimated tax payments are generally due:
- April 15 for income earned January 1 to March 31 (months 1, 2 and 3 of year)
- June 15 for income earned April 1 to May 31 (months 4 and 5 of year)
- September 15 for income earned June 1 to August 31 (months 6, 7, and 8 of year)
- January 15 of the following year for income earned September 1 to December 31 (months 9 through 12 of year)
It is also important to distinguish whether you are an employee (employer can withhold taxes) or and independent contractor (you are responsible for paying taxes) so that you can stay in good standing with the IRS.
If you are a business owner, you may want those who you do business with to submit a W-9 form so that you can withhold taxes or report withholding or payments made to them based on their business identification number or social security number if a sole proprietor.
You too can use Form W-9 to provide your correct Taxpayer Identification Number (TIN) to the person or business who is required to file an information return with the IRS to report, for example:
- Income is paid to you.
- Real estate transactions.
- Mortgage interest you paid.
- Acquisition or abandonment of secured property.
- Cancellation of debt.
- Contributions you made to an IRA.
- Gambling winnings.
Learn more by going to the IRS website…
FICA
The Federal Insurance Contributions Act of 1935 was signed into law to allow money to be withheld to help establish and keep the social security system solvent and ensure that current recipients receive their payments. On your paycheck you will see Social Security withholdings (6.2%) up to a a wage limit which “adjusts annually” and Medicare withholding (1.45%) “which is unlimited” under current law.
The current total tax rate for Social Security is 6.2% for the employer and 6.2% for the employee, or 12.4% total.
The current rate for Medicare is 1.45% for the employer and 1.45% for the employee, or 2.9% total.
The combined rate for Social Security and Medicare employer and employee rate is 15.3% total.
There’s a maximum wage base for Social Security taxes on earnings, above which no tax is levied. The wage base is set at $168,600 for 2024, and for earnings in 2025, the base or “taxable maximum” is $176,100. Again, keep in mind there is no wage base limit for Medicare taxes.
Other
HSA/FSA and retirement accounts are often withheld by employees who elect the withholding and it is usually a wise choice, as that allows for the” lowering of your taxes” since it is done on a pre-tax basis, therefore it does not go into your taxable income calculation and can lead to a substantial financial windfall for you and your family if utilized effectively.
Social Security income does not require withholdings; however you have the option of having taxes withheld if you desire. Medicare payments can also be withheld from your monthly social security payments if you find it convenient to do so and you elect Medicare for health coverage at age 65.
If you received Social Security income you would receive a 1099-SSA form during the tax season and you would include that income along with your other income to determine how much would be taxable up to a maximum of 85%. If you had taxes or Medicare premiums withheld, they would be displayed on form 1099-SSA.
Pension income you can generally elect to have withholdings from pension provider by making the election and completing form W-4p which is very similar to the W-4 process mentioned earlier in this discussion.
Self-employment income does not require withholding, but estimated taxes are expected to be paid to the IRS based on your income at intervals of April 15, June 15, September 15 and January 15 of the new year, so if you are self-employed (or an independent contractor) be aware of your responsibilities.
Failure to pay in a timely manner could lead to a “tax penalty” for underpayment of your federal taxes.
You can deduct ordinary and necessary expenses from your self-employment earnings to help reduce the amount that will be taxable. Among others, the deductions include advertising, commissions, postage, phone, utilities, supplies, medical coverage, office expenses, automobile, equipment, furniture and any other expenses related to your business that qualify according to IRS guidelines, and those expenses can be deducted from your income to help reduce the taxes that you will owe at tax time, thereby “lowering your estimated tax payments” that are due on the dates mentioned above.
You can also use retirement plans, including SEP-IRAs (up to 25% of earnings can be contributed) to further reduce the amount that would be subject to taxation. Self employment earnings of $400 or more would also be subject to SE taxation and you would also be able to deduct 1/2 of your SE tax payment on your personal 1040 return. Your earnings and deductions from self employment as a sole proprietor would go on schedule C and be carried over to schedule 1 and then 1040 page 1.
Your earnings that you pay taxes on through self-employment would be used in the 35-year average that is used to calculate your social security benefits when you retire (generally age 62 to age 70), so be aware of that factor.
Qualified Business Income may offer you the opportunity to pay less in taxes if you qualify and you timely file your tax return.
Gaming/gambling winnings may have tax withholdings up to 24% at the federal level. Be sure to keep good records as winnings can be offset against losses to help reduce your taxes. With certain gambling winnings you would receive a form W-2G during the tax season for winnings you had in the previous year.
Unemployment Compensation you could choose to have taxes withheld or you can choose not to. Unemployment compensation requires the payment of taxes, so be sure to plan for the payment at the federal and possibly state level. If you receive unemployment compensation you would receive a 1099-G during the tax season the year after you received the compensation.
IRAs and retirement accounts may be subject to withholding unless an exception applies. Early withdrawals could also result in an additional penalty. If contributions are done through payroll they could possibly avoid taxation and penalty until withdrawal at retirement time if you did not tap into the account(s) early. Your retirement income would generally be reported to you on form 1099R which is similar in content to that of a form W-2 mentioned earlier, your withholdings would be done through a form W-4p which is similar in scope to that of a W-4 that was mentioned earlier.
Form 1098 although “no withholding” is done on form 1098 Mortgage Interest Statement, it is included in this post due to the importance that it plays in the building of wealth. You would receive form 1098 at tax time and if you are a homeowner, it provides in documented form a statement that includes your outstanding mortgage loan balance (usually balance at beginning of tax year) mortgage points paid if any, principal, and interest paid for the year–along with private mortgage insurance or MIP for those who put less than 20% down at the time of their home purchase.
Escrow payments made for property taxes may also be included. The mortgage interest along with property taxes paid can be deducted on schedule A for those who itemize, and mortgage interest, property taxes along with other deductions, can play an important role in reducing taxes or increasing the refund amount that you would receive. By strategically planning in advance, you can plan from year to year and that planning can play an important role in helping you build wealth more efficiently.
1099-K income is income that is often earned in the new gig economy, and TheWealthIncreaser.com would be remiss not to include this income in this post, as 1099k income is subject to taxation and no withholding for tax purposes are done, therefore it is the responsibility of the recipient of 1099-K income to report the income and pay taxes on that income. Keep in mind the IRS receives a copy of this and virtually all other forms of income that has been discussed in this blog post. Whether you resell clothing, household items or other goods or services and an electronic record is kept–you may have to report that income depending on the amount.
This includes uber, lift, grubhub and a vast array of delivery services and rideshare income that are derived over electronic platforms.
Although there was a back and forth on reporting 1099-K income for several years, the form is now active and online marketplace or third-party apps must report when certain thresholds are met (generally when goods and/or services total over $5,000 for tax year 2024 but scheduled to begin at $600 in the future), therefore if you are part of the gig economy you want to plan now for the payment of taxes.
Other sources of income depending on type, may also be subject to withholding. Also be aware of taxation at the local and state levels as it is important to look at your taxes in a comprehensive or wholesome way and analyze from ALL sources–even when what are really taxes, go by other names.
In addition, liens, child support and garnishment of your pay can occur (involuntary withholdings) and that is the type of withholding you want to avoid as best you can.
Conclusion
It is important that you realize that taxation of income at this time in the United States appears here to stay, and if you have income you want to come up with a way to pay your taxes “as you earn” whether by w-4 withholdings through your payroll withholdings as you earn or through the payment of estimated taxes based on what you earn throughout the year and pay at designated intervals in April, June, September and January.
By timely managing your finances and paying your taxes you can avoid large tax payments and penalties at tax time that could severely hamper your wealth building efforts. Although you are the ultimate decision maker, a refund of $1,000 or owing $1,000 is a reasonable target to aim for, assuming your finances are in order from a comprehensive perspective, and you have a strong money management personality.
By “planning in advance” you can manage your finances and taxes in a manner where you owe a little–or get a little back, thereby minimizing the financial stress in your life, preventing large losses due to fraud, investing what you would otherwise allow the IRS to hold and otherwise manage your finances more optimally. Also, don’t forget about the taxation of your assets upon sale, as in many cases you will be taxed at your ordinary income or the generally more favorable capital gains rate.
Your withholdings along with your standard deduction or itemized deduction amount, and other adjustments deductions and credits will play a large role in determining if you will owe or if you will get a refund in this and the coming tax seasons.
Always realize that “even if you don’t have any income tax withheld” from your wages, you may get a refund if you are eligible for tax credits such as the Earned Income Credit, the Additional Child Tax Credit, American Opportunity Credit and other potential credits that you may qualify for. Therefore, you would want to ensure that you file your taxes in a timely manner (you have a 3-year window to file, otherwise you lose the refund) as that can put you in better position to manage your money at the various stages of your life.
Also, you can elect to file for an extension to pay your taxes (up to October 15th) if you find yourself in the unfortunate position of not planning or planning inappropriately due to lack of knowledge, fatigue, or not knowing about the payment of taxes to the degree that you now know!
You and your tax practitioner can extend the deadline for months (by filing form 4868) to give you additional time to come up with the funds needed to pay your taxes. However, payment is required or at least suggested based on what you expect to owe in taxes–even when extending your time to file.
All the best to your withholding and wealth building success as you deserve nothing less…
Disclaimer – TheWealthIncreaser.com does not provide and does not intend to provide financial, investment, tax, or legal advice. Information contained in this article is for informational and educational purposes only. The inclusion of links to third-party content is not an endorsement by TheWealthIncreaser.com of such content or services but is designed to save you time. Please do your due diligence and use your discretion and additional independent research so that you can come to your own conclusion as to the best approach to take for your particular situation.
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