W-4 Changes for 2020

Two years after the Tax Cuts and Jobs Act of 2017, the IRS revised Form W-4 which tells your employer how much to withhold from your paychecks. I’m going to walk you through the new steps for updating your W-4 in under 15 minutes and possibly reduce your tax withholdings.

Prior to this W-4 change, employees would first state whether they were “Single” or “Married”. If the taxpayer was married, they could also select “Married, but withhold at higher Single rate”. This was common if both spouses worked. From there, employees would calculate their number of “allowances” and any “additional amount withheld from each paycheck”. 

Somehow, taxpayers, employers, and advisors became accustomed to this convoluted system. I mean, what is an “allowance” anyway? Isn’t this something kids get rather than something that goes on a federal tax form? Thankfully the IRS simplified with the new Form W-4 and has a great tool to make sure you make the best payroll tax withholding elections for your situation.

Step A - Find your most recent paycheck

You need to know the frequency of your paycheck (weekly, every other week, twice a month), paycheck date, annual base wages/salary, period and year-to-date federal taxes withheld, and pre-tax cafeteria plan deductions. 

Go ahead, write this information down. Step 2 will be here when you return.

Step B - Begin using the IRS estimator

Go to https://www.irs.gov/individuals/tax-withholding-estimator and click the “Use the Tax Withholding Estimator” button.

Step 1 - About You

Answer questions based on your situation.

Step 2 - Income & Withholding

Enter your

• annual base salary, 

• bonuses received (including commission, restricted stock, etc), 

• period and year-to-date federal tax withholdings, 

• expected annual pre-tax 401(k) plan contributions, 

• expected annual cafeteria plan contributions

Also, enter your expected bonuses (plus commission, restricted stock, etc). Remember to check the box for “My employer will withhold the appropriate taxes from this future bonus”. Bonuses (aka “supplemental income” in the tax code) have a flat 22% tax withholding, up to $1 million of income.

Step 3 - Adjustments to Income

Complete if necessary. Will not apply to most taxpayers.

Step 4 - Deductions From Income

Complete if necessary. Most people take the standard deduction under the new tax law.

Step 5 - Tax Credits

Complete if necessary. Most commonly used credits are related to your children - enter the number of kids under age 17, and the number of children under age 13 with dependent care expenses if both spouses work.

Step 6 - Results

See the calculator’s results. If you have an expected refund, you can move the toggle to the left. The tool will provide next steps to reduce your paycheck tax withholdings and the expected refund amount. The calculator will print a pre-filled W-4 for you to complete, sign, and provide to your employer. Nice! 

If you have an expected tax amount due, you can take the tool’s recommended steps by making additional withholdings on your W-4 and submitting the form to your employer. Or you can investigate a little further and you may find the amount due is related to your received or expected bonuses.

Unfortunately, the tax problem some professionals and executives have is related to bonuses, commissions, restricted stock, etc. (“supplemental income”). This income is taxed at a flat 22% tax rate rather than the taxpayer’s marginal tax rate. For example, when a couple’s taxable income is greater than $325,000, their marginal tax rate is 32% or higher. This tax rate difference leaves them with a big tax bill the following year. 

So rather than entering “an additional withholding per pay period” (Line 4 (c) on Form W-4). I usually recommend making a separate estimated tax payment after receiving your supplemental income. This way, your future paychecks are not paying taxes on a bonus already received. Here’s an easy way to do that.

Step 7 - Determine Tax Attributable to Bonus/Commission (Optional)

Make a note of your tax “Estimated under payment”. Go back to the “Income & Withholding” step to review your Bonus amounts. Allocate your “under payment” between bonuses “already received” and “expect to receive later”. 

For example, if the “under payment” is $10,000 and the bonus “already received” is 30% of your total bonus, then the “under payment” for “already received” is $3,000. The remaining $7,000 of tax “under payment” is for what you “expect to receive later”.

Then, pay the additional estimated tax from your bonus. The easiest way to make an estimated tax payment is to visit https://www.irs.gov/payments/direct-pay and pay the IRS directly from your bank account after your bonus is received.

Finally, you should still complete, sign, and provide the W-4 to your employer, but you can remove the additional holding amount in Line 4(c).

I’m happy to speak with you about your own unique tax planning questions and answer questions you may have. You can also sign up for our newsletter to receive regular updates and ideas like this to help you make smart decisions with your money.