After tax season, many people find themselves in the position where their tax preparer/accountant recommends that they change their withholdings. This typically happens when a person has prepared their return and either has a large refund or balance due. The rule of thumb most will use is that if either of the above is roughly 3% or more of your gross annual salary, you may need to make some changes.
How Form W4 Works
Form W4 is used to tell your payroll department how much you would like taken out of your pay for Federal Income Taxes. You will also have to fill out this form in you live in one of the 41 states that impose an income tax. The simple way to think of this form is that every number listed on the form (called an allowance) is supposed to represent a member of your household. So the greater the number of allowances on the W4, the smaller the amount of taxes withheld becomes. The smaller the number is on the W4, the greater the amount of taxes taken out becomes.
What Are Allowances?
As mentioned above, a withholding allowance is generally meant to represent each member of your family that will be claimed on your tax return. Just you by yourself? Claim 1 allowance. Are you married? Maybe you will claim 2, one for each spouse. Have 3 children? Then it could be 5, one for each spouse and 1 for each child.
Should I File Exempt From Withholding?
Generally speaking, there are very few individuals who should EVER claim that they are exempt from withholding. This is honestly one of the fastest was we see people get into trouble with the IRS and create mountains of tax debt.
The only people who should claim this status are 1) those who do not have a filing requirement and 2) those who were entitled to a full refund of ALL amounts withheld in the previous year. To learn more, take a look at Publication 505 and look at the section