What Is Federal Tax Withholding?

We know just thinking about taxes can make you want to take a nap and not wake up till April’s over. (Same.) But like it or not, you’ve got to arm yourself with knowledge so you don’t end up in trouble with Uncle Sam (he can get a little cranky when it comes to his money) or overpay him all year. It all comes down to getting your federal tax withholding set up just right on the front end.                                                                                                               

So what’s the deal with federal tax withholdings? Glad you asked! Let’s dive into what you need to know.

What Is Federal Tax Withholding?

Basically, federal tax withholding is where your employer takes  a certain amount of money out of your paycheck for taxes and sends it to the federal government on your behalf.

When tax season comes around and you finish filing, you’ll either get a refund or owe additional taxes. A lot of people think getting a nice juicy refund is like getting free money. Nope! All a big refund means is that you’ve been loaning Uncle Sam your hard-earned cash interest-free. All. Year. Long. Um, pass.

Don’t settle for tax software with hidden fees or agendas. Use one that’s on your side—Ramsey SmartTax.

You want to go for the Goldilocks approach. Too much withheld and you’re giving Uncle Sam money without any interest. Too little withheld and you’ll end up owing the government money. You want your withholding to be just right so you break even when tax time rolls around. If you haven’t recently, check with your employer to make sure you’re having them hold back just enough to cover your tax obligations (we’ll show you how to do that below).

How Does Tax Withholding Work?

Here in the good ol’ U.S. of A., everyone who earns an income is supposed to pay income tax to the federal government (and your state, if you live in one with a separate income tax).

When you start a new job—or have a major life change, like getting married or having kids—you’ll need to fill out a W-4 form. This form tells your new employer how much money to take out of your paycheck for taxes.

So, what if you’ve been at your job for a while now and you haven’t had any big life changes in the last year? Well, you don’t necessarily need to fill out a new W-4 form each year, but it’s a good idea to make sure you’ve got your withholding set up right. If you’ve consistently owed taxes or gotten a huge refund each April, you need to take a closer look at your W-4.    

What Changed in 2020?

Another reason to check in on your withholdings this year? The IRS gave the W-4 form a big makeover starting in 2020. The new form was redesigned to make it easier to understand and to make the whole withholding process more accurate and crystal clear. Good on them!           

The W-4 change is a result of the 2018 tax reform bill. Since the bill got rid of personal exemptions, the new W-4 form has done away with using “personal allowances”—like claiming “1” if you’re single and have one job or claiming “3” if you’re married and have one child—to figure out how much to withhold from your paycheck.

But the basics of the form are the same, so no need to panic! This isn’t a complete overhaul. The new W-4 form just replaces the old headache-causing worksheets with simplified questions, which makes it easier to fill out all your iinformation and make sure you’re getting your tax withholding right.

How Does the New W-4 Work?

Thankfully, the new W-4 form was designed to be more taxpayer-friendly. There are five steps, or sections, that you’ll need to fill out, but not every step may apply to you. Don’t worry—it’s simpler than you think.

Here’s what you’ll fill out:

• Step 1: Name, address, Social Security number and expected filing status (for example: single or married filing jointly)
• Step 2: Any side hustles, other jobs and income from your spouse
• Step 3: Any children or other dependents
• Step 4: Any extra income and any extra withholding
• Step 5: Your signature

Once your John Hancock’s on the dotted line, voilà! You’re done filling out your W-4.

Remember, you don’t want too much taken out—just enough to appease your favorite Uncle Sam.                                                                                                                                                   

How to Determine Your Federal Tax Withholding

Your withholding amount depends on a couple things, including how much income you earn and the information your employer receives when you fill out your W-4 form.

You can figure out the right amount of tax withholding a couple of ways. The first—if you want to be super thorough—is doing a mock tax return. That will show exactly what you would owe for the year. If you get paid every two weeks, divide that tax bill by 26 (divide by 24 if you get paid twice a month), and you’ll have the amount of tax that needs to come out of each paycheck—assuming your income stays the same all year.

Another way is to take a look at the last year and see if there’ve been any major changes in your life. Did you buy a home, have a baby, get married? Things like that will affect your tax bill, so you should update your W-4 right away so your withholding is as spot on as possible.

Let’s say you didn’t have any major changes last year and for the last few years you’ve had a $3,000 refund. You’d want to adjust your W-4 so you don’t get a refund. Why? Because that $3,000 refund comes out to an extra $250 in your pocket each month. Think that could make a big difference in your monthly budget or your debt snowball? Heck yes!

If you’ve still got questions or you have a complicated tax situation, connect with a tax pro to help you get the adjustments right.                                                                                                                                                   

Get Started with Ramsey SmartTax

Okay, we know. That’s a lot to keep in mind—and yes, there’s some math involved. But you don’t have to dig through the numbers alone! If you have a relatively simple return and want to try filing on your own, go for it! For an easy and straightforward online solution, check out RamseySmartTax. No hidden fees, no advertisements, no games. That’s how it should be!

If you’re not comfortable handling it by yourself, however, reach out to a tax Endorsed Local Provider (ELP) in your area. They can help you make sure you’re on the right track through the whole tax process. (Hello, peace of mind!)       

Find a Tax Pro today!