Ensure that you are in compliance with Federal law by having all new employees complete Form W-4.
Signed and dated copies should be kept in every employee personnel folder for future reference. This is a safe, easy way to comply with the law.
Employers collect Form W-4 information from employees so they know how much money to withhold from employee paychecks for employee federal tax withholding obligations.
The official name for the W-4 Form is the "Employee's Withholding Allowance Certificate," but most people just call it the W-4.
We'll get to the specifics of employee and employer W-4 obligations, but let's first understand how we got here.
History of the W-4 Form
The W-4 came into existence during World War II. That's when Congress introduced the concept of modern-era payroll tax withholding in the Current Tax Payment Act of 1943.
Income tax had previously become a permanent part of American life back in 1913, when the 16th Amendment passed.
There were some attempts then at withholding, but in 1917, the withholding requirements were dropped. Employers had fought against their new role of having to be tax collector for the government, and they won.
But it was a short-lived victory.
As we all now know, employers in the United States today set aside a portion of their employees' paychecks to cover employee tax obligations for federal income tax, state income tax, Social Security, Medicare taxes and other local taxes.
The expense of World War II, coupled with the passing of the Social Security Act in 1935 and the complexity it added to employee tax obligations, gave Congress the justification to get employee tax withholding back into official law in 1943, and thus the W-4 was born. (Here's a copy of the 1943 W-4 Form, the very first W-4 form, if you like to geek out on IRS history.)
Until then, employers were not in the role of tax collector, and each citizen just paid their taxes in full on March 15, which was the due date for taxes up until 1954, or on April 15, the date that we now all know and love for when our personal income taxes are now due.
How much income tax is withheld from an employee paycheck depends on how the employee fills out the W-4 form. So, it's a very important tax form.
It's so important that the law requires every employee to submit a W-4 to their employers when they take a new job. It's also important for state income taxes, with many states using the federal W-4 form to calculate state tax withholding amounts (although some states have decided to create their own state specific equivalents of the W-4 form).
The W-4 form is important in another big way, as well. If you think about it, the W-4 form is the first interaction most of us have with the US tax system. You get that first job in high school or college, and the boss hands you a W-4. It's a bit intimidating for the uninitiated.
But, fortunately, for both employers and employees, we've got you covered. Let's talk about the latest version of the W-4 form and how it works.
2020 Changes to the W-4 Form
The IRS has an excellent set of W-4 resources that are worth checking out. But, it's a lot to digest so we've got the most important info for you here.
Why did the IRS change the W-4 form in 2020?
In years prior, the W-4 form allowed you to enter a number of "allowances" that informed an employee's employer as to how much tax to withhold on each paycheck. If you put down a high number of allowances, your tax withholding would be low. Similarly, if you entered a low number of allowances, then withheld taxes would be higher.
Fast forward to 2020 and allowances are no longer a thing.
Trump's 2017 Tax Cuts and Jobs Act eliminated personal exemptions, which had previously ensured that poorer families were not subject to income tax. (They balanced that out on some other fronts, we should add.) Personal exemptions coupled with W-4 allowances allowed employers and their payroll services to precisely calculate the amount of tax to withhold. Without personal exemptions, the value of the concept of allowances was thrown into question -- and in the end the IRS jettisoned the concept of allowances.
So, no more allowances field on the W-4!
Now you know. And if anyone asks you why the W-4 form had to change, the short answer is that tax code changes made some parts of the W-4 form wrong or irrelevant.
Cool. You now have a fun fact to share at your next cocktail party. Congrats!
How the 2020 W-4 Form Works
Good riddance to allowances, Many of us had no idea how they worked anyway, right? But how does the 2020 W-4 form work?
On the new W-4 form, the employee provides other information that lets the employer know how much payroll tax to withhold. That includes items like income from other jobs, number of dependents, expected filing status and the tax deductions you intend to claim.
If you're an employer, expect your employees, particularly older ones, to be confused. The concept of using allowances to define tax withholding has been around for ages, so it's going to take some time to adjust. Younger employees, on the other hand, may not be as befuddled but will likely still need some handholding.
For employers, it's also important to know that any employee that starts their job after 2019 has to use the new form. You can't keep handing out old W-4 forms.
However, you are not required to get all your employees who filled out their W-4 forms in prior years to change and use the new form. The exception is if one of those pre-2020 employees wants to change their tax withholding, in which case they must use the new W-4 form.
Should you talk to employees about the W-4 form and its implications?
Well, while there's always a fine line on giving employees personal finance advice, the reality is that many tax code changes in recent years have led to employees being under withheld and owing a lot of taxes.
When this happens, they are often mad not just at themselves, but also at their employer for not withholding enough. (OK, so maybe they were happier the entire year while they got their fatter paychecks, but you should still help them to avoid getting a big negative tax surprise on April 15.)
Our advice is to spend time with your employers explaining how the W-4 works and check in with them when their tax situation may have changed (e.g. they bought a house, are getting a big bonus, are about to get married). Employees appreciate the advice, but always include the disclaimer that you are not giving them tax or financial advice.
As a final word of advice, a great resource to send employees to is the IRS Tax Withholding Estimator, which can help your employees make sure they have the right amount of tax withheld from their paychecks.