Hiring staff is essential for business growth. Whether you're planning to expand your services or enter new markets, you will need the right people on your team. Being an employer has its perks, but it also puts a lot of responsibility on your shoulders. One of the first tasks on your checklist is to ensure that your new employees complete Form W-4.
Form W-4 underwent major tax law changes in 2020. As an employer, it's important to familiarize yourself with the current version of the W-4 and explain these changes to your staff so they fill it out accurately.
Employer Payroll Tax Obligations
As an employer, you are responsible for collecting, withholding and reporting payroll taxes on behalf of your employees. Employers must report any wages, tips and other forms of compensation paid to their staff and withhold federal income tax and Medicare/Social Security taxes accordingly. To determine the amount of taxes to withhold, they may use the IRS Employer's Tax Guide and Form W-4.
The withholding amount must be deducted from employee paychecks and include the following:
- Federal tax, local tax and state tax
- FICA (Federal Insurance Contributions Act) taxes
- Contributions to state and federal workers' compensation funds
- Unemployment taxes
FICA taxes, for example, consist of Medicare (1.45%) and Social Security (6.2%) and must be paid by both employers and employees. The right amount to withhold from your employees' paychecks depends on what they put on W-4 form. It depends on several factors, such as their marital status and any withholding allowances they claim. Employers must then send this information to various tax agencies.
Business owners are also responsible for depositing the federal income tax withheld, filing payroll tax returns, preparing reconciliation reports and more. Therefore, they need to know how and when to file Form W-4, Form 941, Form 945, Form W-2 and other documents. Considering these facts, it's not surprising that 39% of U.S. employers outsource payroll, and about 43% outsource tax processing. The complexity of performing payroll increases if you hire more people or open offices in multiple countries.
What Is the W-4?
The W-4 is a tax form that must be filled out by employees for tax withholding purposes. With this information, employers can determine how much tax will be withheld from their paychecks and sent to the IRS.
Also known as the Employee's Withholding Certificate, this tax form must be completed annually or whenever an employee's personal or financial status changes. As an employer, you can assist your staff with filling out the W-4 to prevent them from overpaying or underpaying their taxes. Generally, companies ask new employees to complete this form on the first day of work. Unfortunately, many taxpayers don't understand its impact on their income or fail to claim the allowances to which they are entitled.
Although you're not legally required to help your employees fill out this form, it's recommended that you do so to determine the correct amount to withhold. This will help instill confidence in your workers, resulting in better job satisfaction. If the W-4 is inaccurate, your employees may end up paying too much or too little in tax. Furthermore, they may not qualify for unemployment benefits, Social Security or Medicare, which can affect their quality of life.
If for some reason an employee doesn't fill out the tax withholding form, he will still get paid. In this case, the employer will withhold income taxes at the highest rate. Employees who get married, have a child or experience major financial changes must complete a new W-4 so that they pay taxes accordingly. Self-employed individuals, freelancers and small-business owners are required to withhold their own taxes.
Understanding the New W-4
The W-4 Employee's Withholding Certificate was revamped in 2020, creating a lot of confusion among employees and employers alike. The new form is completely different than its previous version, asking taxpayers to provide additional information, such as any anticipated deductions and tax credits. Additionally, it no longer relies on the concept of withholding allowances.
At first glance, the 2020 Form W-4 can't get much simpler. It's one page long and has only five sections; some steps must be completed only if they apply to you. Most sections include questions and possible answers. However, if you scroll down, you will find several worksheets and tax-withholding tables that make everything a lot more complicated.
Employees hired before 2020 are not required to fill out the new W-4 unless they want to make changes to the tax withheld after January 1, 2020. All new hires in 2020 must use the new W-4. If they refuse to fill it out, they will be taxed as single filers with no adjustments. The IRS recommends that employees who hold more than one job at a time or have a side hustle to increase their withholding, which requires completing the new form.
There Are No More Allowances
The previous versions of the W-4 allowed employees to reduce their income tax by claiming allowances. For this reason, this tax form was referred to as the Employee’s Withholding Allowance Certificate. The new W-4 doesn't include the word "allowance" in its title anymore because allowances are no longer used. According to the IRS, this change is meant to make tax withholding simpler, more accurate and more transparent and to ensure compliance with the Tax Cuts and Jobs Act requirements.
Until the end of 2019, employers used the total number of allowances claimed by employees to determine how much they have to pay in income tax. The more allowances an employee claimed, the less money was withheld from her pay. Employees were able to claim allowances for themselves and their spouses or children as well as for other reasons, such as being single.
For example, single taxpayers with only one job and no children were able to claim two allowances. Those who were married and filed jointly were able to claim more allowances based on their income, the number of jobs and whether or not they had children.
The new W-4 doesn't use this concept anymore. However, it's a lot simpler because taxpayers no longer have to determine the number of allowances to which they are entitled. Additionally, they may use the IRS tax-withholding estimator to figure out their federal income tax withholding.
Filling Out Form W-4
Filling out the 2020 Form W-4 is more or less simple depending on the employee's situation. For example, single taxpayers who are not claiming any itemized deductions or tax credits and have just one job only need to submit their name, Social Security number, home address and filing status. Head of households will see different rates than dependents, and whether or not this is their second job and if their spouse works will also affect their tax rates. Those with a more complex situation must provide more information, such as their income from other jobs or side gigs and their spouse's earnings.
- Step 1: Enter the employee's personal information, such as his name, home address and marital status.
- Step 2: This section is designed for employees who are married filing jointly and have a spouse who also works and for those holding more than one job.
- Step 3: Complete this section only if you have children or other dependents.
- Step 4 (optional): Employees may provide information about any additional income they earn, such as retirement plans or dividends, extra withholding or itemized deductions – like state and local taxes up to $10,000 – or mortgage interest.
- Step 5: The employee provides a signature.
All employees must complete steps 1 and 5. Steps 2-4 are required only if certain criteria apply. Employees who have children or other dependents must do a little bit of math when completing step 3. Basically, they need to multiply the number of children under age 17 by $2,000 and the number of other dependents by $500 and then enter the total amount of money in the designated field in order to receive the child tax credit.
Employers must sign the form and submit their name, address and tax ID number. They also have the legal obligation to keep employees’ W-4s in their payroll files for four years after the date their taxes are paid or become due, whichever is later. Form W-4 can be completed and signed online as long as the procedures for valid electronic signatures are followed. This requires using a digital-signature software program, such as eSign Genie, SignRequest or DocVerify.
How to Help Your Employees
As an employer, it's not your responsibility to help employees fill out the W-4. They may contact a tax preparation firm or a tax adviser to assist them in completing this form. However, it's in your best interest to help them. This can help strengthen your relationship and ensure they won't experience any issues with their wages and benefits.
First of all, explain to them what the W-4 is and why it's important to fill it out accurately. Second, you may help them complete the form or ask someone from your HR department to assist them. Make sure they provide any required information and sign the form to make sure it is valid. Ask them to complete Form W-4 when they begin work for your company.
Employers don't have to send the W-4 to the IRS, but they are legally required to keep it on file for four years or longer, even for workers who are fired or quit their jobs. Depending on your preferences, you can order multiple copies of the W-4 for your employees, download and print the form from the IRS website or call 800-TAX-FORM. Another option is to use a substitute form that uses the same language as the official W-4 and contains the same additional information, including tax-withholding tables, worksheets and instructions.
Exemption From Tax Withholding
Some of your employees may not have to pay federal income tax. Generally, the exempt status applies to those who had no income tax liability in the previous year and expect to have no tax liability in the current year. Those who meet these criteria must complete steps 1(a), 1(b) and 5 on the new Form W-4 and write "exempt" in the space below line 4(c).
Let your employees know that the exemption only applies to their income taxes. It does not apply to their federal unemployment, Medicare and Social Security taxes. These taxes must be paid by both employers and their employees. Therefore, even if one of your staff members claims exemption from tax withholding, you must still pay your contribution to these taxes as an employer.
If you suspect that an employee's W-4 is inaccurate or invalid, you have no right to change it or subject them to additional withholding. However, let her know about the consequences of her actions. The information she provides when filling out the form may be questioned by the IRS. If the form is invalid, you are legally required to withhold federal income taxes from her paycheck at the highest rate. Visit irs.gov for additional info.
- IRS: Depositing and Reporting Employment Taxes
- NerdWallet: How FICA Tax and Withholding Tax Work in 2019-2020
- Robert Half: 2016 Benchmarking - The Accounting and Finance Function
- University of Massachusetts Amherst: New Federal Tax Form W-4 for 2020
- IRS: Tax Withholding Estimator
- IRS: FAQs on the 2020 Form W-4
- IRS: Topic No. 753 Form W-4 – Employee's Withholding Certificate
- IRS: Form W-4 Employee’s Withholding Certificate
- IRS: Employer and Employee Responsibilities - Employment Tax Enforcement