HOW DO I CHOOSE MY EXEMPTIONS?
The most common tax questions I deal with--especially during tax season—surround the topic of adjusting one’s personal exemptions on a W4. So here are the 5 most important things you should know about exemptions and how to fill out your W4 correctly.
Number 1: Exemptions and Allowances, Yes There is a Difference!
The word “exemptions” is misused in our vernacular and this is a major source of confusion when it comes to understanding how to fill out your W4. Please note: Exemptions are to your year-end 1040 form what Allowances are to your W4 form. This is the terminology the IRS uses to distinguish the two. So when people ask me about how to choose the right Exemptions on their W4, they are really asking: how many Allowances should I be claiming on my W4 form?
Number 2: How Do Allowances Affect My Income?
First lets talk about the W4 form and allowances. Many people misunderstand the purpose behind allowances. This is most evident when I advise my clients to increase their W4 allowances, and, more often than not, the taxpayer responds with: “Can I claim X number of dependents if I don’t have any children?” Or another common response: “My wife already claims my children on hers, I can’t get credit on mine too, right?”
The number of allowances on your W4 does not correspond to whether or not you are married or have kids. The W4 just gauges how much or how little money will be withheld from your weekly, bi-weekly or monthly paycheck. When you choose to take more allowances, it means the government takes out less taxes from your paycheck, and when the government takes out (or withholds) less, you will receive more of your income every month in your paycheck.
Number 3: It’s Not Just a Number In a Box
In fact, this one decision of choosing a number is very important because it directly affects your family’s quality of life since it determines how much take-home pay you receive monthly. And you don’t want to just pick a large number so a small amount of taxes are taken from your pay, because you could end up owing a lot of money come tax time.
This is when it’s a good idea to consult a Certified Public Accountant. In fact, I’ve encountered many people along the way who fill out the W4 based upon the instructions directly on the IRS form and it resulted in insufficient withholdings. This could result in under withholding penalties if 110% of your prior tax liability is not met.
Number 4: Don’t “Set it and Forget it”
Many people start filling out all their necessary paperwork, including the W4, when they first start working with a company. Then they “set it and forget it” for lack of better terms, unless something dramatic happens, and they either end up owing a lot or getting a huge refund. When asked many people can’t answer how many allowances are claimed on their W4. There are many reasons to regularly revisit your W4, for starters here are two:
- If a taxpayer or spouse will fall into the new Medicare surtax (.09%) and either wants to maintain their current refund (or liability) level, they can change their allowances or add an additional withholding amount to achieve thisor simply add a specific dollar amount.
- · When your allowances are low, it can lead to a very large tax refund. Basically you’ve lent your money to the government interest freeby overpaying your taxes throughout the year. Instead ask your payroll department, can I get my paystub direct deposited into two places? You can take any additional money you get in your paystub--because you increased your allowances--and accumulate savings preferably in an interest-bearing account that you don’t access on a regular basis.
Number 5: Exemptions and Your 1040
Getting back to exemptions…unlike allowances, exemptions relate to your 1040 and are tied to things that are related to the number of family members and your current situation. On your federal tax return, you get what’s deemed to be a personal exemption for yourself, as well as your spouse and any dependents. You indicate the total number of exemptions for each category and then multiply the total number of exemptions by the annual rate for each exemption. Added together, this is what ends up being a deduction on the second page of your 1040. Remember, this is different from what you claim on your W4, because tax deductions on a 1040 are settled up at the end of the year vs. W4 allowances, which affect the amount withheld of your wages.
If you’re still confused, take heart, you’re not alone. The tax law is not easily understood which is why people hire professional CPAs in the first place!
Stephen F. Mankowski is the owner of the CPA firm Quantum Management Services, Inc located in Hatboro, PA. He has been a CPA since 1989. The primary focus of his practice is small to emerging businesses as well as individuals and his experience spans many industries. He is on the National Board of ncCPAp and says he joined because he “can leverage the collective expertise of thousands of accountants for the benefit of his clients. When a unique tax problem arises and a tough call needs to be made, it’s a great resource.”