Federal Income Tax is a pay-as-you-earn system of tax. Accurate calculation of the amount of tax withheld requires some basic information from the employee. They provide this information to you on IRS Form W4.
In the past, the tax was calculated using withholding allowances, The value of a withholding allowance was tied to the amount of the personal exemption. The more allowances an employee claimed, the less income tax you withheld from their wages, and vice versa. But in 2018, a modification to tax code that eliminated the use of withholding allowances took effect. In response to this change, the IRS modified the W4 form to increase transparency, simplicity, and accuracy of it. That first happened in 2020, and it was recently updated for 2022.
Your employees are only required to complete the new W4 form if their first paycheck was received on or after January 1, 2020 or in several other circumstances. For example, if they have married, divorced, had children, changed jobs, or added a job cine they completed the form, it’s important to fill out a new form to ensure their withholding is correct. If you are uncertain, it may be a good idea to have all your employees update their W4 forms to the latest version.
The updated form should be less confusing and faster to complete. If an employee elects to withhold federal income taxes based on marital status alone, they only need to complete Step 1 (Enter Personal Information) and Step 5 where they sign and date the form. It is within optional steps 2, 3, and 4 on the redesigned Form W-4 where the significant changes begin.
Married taxpayers or taxpayers who have dependents or more than one job have to enter a little more information. If they hold multiple jobs or have a spouse who is also employed, they must complete Step 2, and then fill out Steps 3 and 4 for just one of the jobs (for the most accurate calculation, the IRS says to use the highest paying job). The IRS provides a Tax Withholding Estimator calculator to guide employees through the process of estimating their withholdings on the IRS website (https://apps.irs.gov/app/tax-withholding-estimator).
Why you need to know this
If you fail to withhold taxes from employee wages, you could be held liable for the money by state and federal agencies. And that amount may also be subject to penalties based on the number of days late the payment is. So, while it is not your responsibility to ensure the accuracy of the W4 form, it is in your best interest to ensure that every employee has completed one and that you are withholding (and submitting) the tax based upon the employee’s completion of the form.
This can present a potential – and largely hidden – financial impact to your business. As advisors who consider every avoidable possibility for a reduction in profitability, we like to keep you advised of more significant changes that do not directly affect your business 99% of the time, but may unexpectedly become an issue.
Do you have updated W4s from all of your employees? Are the rest of your financial documents in order? Are you submitting the required withheld taxes on time? If you’re not sure, let’s have a conversation.