Having to pay taxes is an unfortunate fact of life, and filing tax returns is one of the most hated activities that Americans have to do. Yet the most important tax form that you'll ever fill out actually has nothing to do with the returns you file in April -- or October, for those who like living on the edge with their extensions. In fact, many people only file this form once. Yet it has a profound impact on your taxes, often determining whether you'll get a refund or end up owing money to Uncle Sam come April. Let's take a closer look at this key tax form and why it's so important.
Continue Reading Below
Image source: IRS.
Form W-4: the linchpin of your taxes
The most important tax form for most taxpayers is one that you only have to file when you start a new job. Form W-4 is called the Employee's Withholding Allowance Certificate, and it's only half a page long. However, the impact that it has on your taxes is huge, and even though many people tend to pay little attention to it amid the flood of new documents you have to sign when you begin a new career, Form W-4 deserves more attention than it usually gets.
Continue Reading Below
What Form W-4 does is determine how much your employer withholds from your paycheck to cover your federal tax liability. As you'll see on the form, the two key aspects of that calculation are in the total number of withholding allowances you claim on line 5, and the additional amount (if any) on line 6 that you voluntarily have withheld from each paycheck. In addition, your marital status on line 3 has implications for the withholding amount that goes to Uncle Sam.
Why most taxpayers are scared of Form W-4
The problem with Form W-4 is that even though it looks simple on its face, it's actually fairly complicated. The Personal Allowances Worksheet that helps you fill out line 5 on the form is harder to complete than the W-4 itself, and it looks a lot more like a tax return.
Image source: IRS.
To complete the worksheet properly, you'll need to know key information like how many dependents you have for tax purposes, how much in child care expenses you'll have, and whether you'll be able to claim key credits. In addition, answers can vary depending on how many jobs you have and whether you have a spouse who works as well. Perhaps most confusing is the fact that some answers on the form look like they have wiggle room, giving you different ways to interpret them. Indeed, the IRS itself makes it clear that you can always claim fewer exemptions than you're entitled to take.
What to know about Form W-4
Even with the confusion surrounding Form W-4, the most important thing to know about the form is that it's merely a tool that you can use as part of your own tax management strategy. The federal government sets up Form W-4 in such a way that it often withholds slightly more than is necessary for tax purposes. As a result, most taxpayers end up getting at least a small refund at the end of the year. Moreover, some workers claim fewer allowances than they're entitled to take, and that can lead to even more withheld tax and a greater refund when you file your return.
However, as nice as a refund can be, you might prefer to keep more of your money in your paycheck in the first place. Claiming more allowances reduces the amount of tax withheld, boosting your paycheck. You might not get a refund and in fact could end up owing taxes in April, but as long as your remaining tax bill isn't so large that you end up owing underpayment penalties, the choice is yours.
Most importantly, filing a new W-4 with your employer is critical when your personal circumstances change. Changes in marital status or having children can have a dramatic impact on the proper withholding, so keeping your W-4 up to date will help prevent any problems from arising.
Form W-4 isn't among the tax forms you'll file with your return, but it's still the most important form you complete. By paying closer attention to it, you might be able to unlock more money from your paycheck and manage your taxes more effectively.
The $15,834 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.