When employees are starting a new job, there are a flurry of new forms to complete, including a W-4: Employee Withholding Allowance Certificate. The purpose of this form is to estimate how much tax will be owed for the current year based on your exemptions and income. This number is divided by the number of paychecks you will receive and withheld and submitted to the US Treasury by your employer. Of course, the tax code is much more complicated than just looking at two numbers (income and exemptions) so you have the option to give a dollar amount to withhold based on your unique situation.
If you get a large refund, it means you significantly overestimated and gave the US Government interest free use of your money until you received your refund, usually in the spring of the following year. If you owe a large amount of money, it means you significantly underestimated the tax and may now be subjected to penalties for not having enough withheld during the year.
The goal is to come as close as possible to the actual tax you will owe so that you are not having to write a large check to the IRS or giving the IRS use of your money when you could have it in your bank account throughout the year.
The W-4 should be reviewed annually to ensure that the proper tax is being withheld. Here are some common events that are likely to have a significant impact on the tax owed. Please note that this is not an exhaustive list.
An increase or decrease in the amount of overtime paid.
Working for multiple employers.
Loss of a job.
Starting a business.
Adding dependents to your return.
Dropping children as dependents from your return.
A change in itemized deductions or tax credits.
If any of these events has occurred, or may occur this year, use the IRS withholding calculator or meet with your tax advisor to determine if you should file a new Form W-4 with your employer. These forms can be submitted to your employer at any time.