If you’re starting a new job or want to lower the amount of federal income taxes your employer is withholding from your paycheck, including deduction allowances when filling out a W-4 form enables you to avoid the consequences of withholding too much federal taxes. The IRS allows you to claim as many W-4 deductions as you’re legally entitled to.
Technically speaking, there is no specific limit to the number of deductions you can claim on your W-4. However, it is essential to ensure that you are legally eligible to claim deductions in order to ensure that you don't violate IRS policies.
Federal tax law requires employers to withhold enough money from the paychecks of most employees to cover their employees’ annual federal taxes. Employers remit the monies to the U.S. Treasury throughout the year. To determine the amount that employers should withhold for federal taxes, employees fill out IRS Form W-4, Employee's Withholding Allowance Certificate. This form includes three worksheets to help employees determine how many allowances to claim.
The Personal Allowances Worksheet allows you to claim yourself, your spouse, your dependents and two specific types of credits as allowances. The Two Earners/Multiple Jobs Worksheet enables you to determine how many allowances to claim if you and your spouse both have a job or if either or both of you have more than one job.
The W-4 Deductions and Adjustments Worksheet helps you estimate the itemized deductions that you plan to declare on your next federal income tax return, or Form 1040. Common itemized deductions include charitable contributions, state and local taxes, and home mortgage interest. When estimating deductions on a W-4, use the Schedule A amounts from your most recent federal income tax return and make any necessary adjustments for the current tax year. Complete the worksheet to determine your deduction allowances. If you did not file a Schedule A with your previous year’s return, but plan to itemize deductions on your current year's federal tax return, use IRS Schedule A to estimate your deductions. Complete the worksheet to determine your deduction allowances.
Impact of W-4 Deductions
W-4 allowances reduce the amount withheld from your wages for federal taxes. In 2010, each allowance reduced taxable income by $3,650. The greater your W-4 deductions, the more allowances you can claim.
Choosing not to claim W-4 deductions may result in your employer's substantially overwithholding taxes from your paycheck. Although you will recover these funds by receiving a larger tax refund, this outcome is not optimal in most cases. You could have been spending, saving or investing that money instead of, in effect, giving the U.S. Treasury an interest-free loan.
Wage earners should aim to have their withholding roughly equal their actual federal tax obligation. A common strategy is to claim deductions and other W-4 allowances so that you either receive a small refund from your annual income tax return or owe the federal government a small amount. Be careful not to claim too many deductions and allocations. If your employer withholds significantly less than your actual federal tax burden for the year, you may have to pay interest and a penalty for underpaying withholding taxes.
You should carefully review your W-4 each year, especially when there are significant changes to the tax code, like for the 2018 tax year. The IRS provides an online withholding calculator to help you determine your optimal withholding level (see Resources).
Grygor Scott has written professionally since 1991, with a focus on law, government, food and travel. His work has appeared in "New York Resident" and on several websites. The author of more than 20 nonfiction books, Scott graduated with honors from the University of North Carolina School of Law.