Whether you’re a business owner or an employee, payroll tax forms have a direct impact on your tax liability. Two related documents, Form W-4 and Form W-2, often cause confusion because their names are so similar. But their functions are very different.
The W-4 is an Internal Revenue Service form used by employers to collect employee data and calculate how much tax to withhold from employee paychecks. Whereas the W-2 lets the IRS know the amount of tax that has been withheld from an employee’s annual income.
Let’s take a closer look at the differences between W-2 and W-4 forms.
What is a W-4?
The W-4 is a tax form that’s also sometimes called the Employee’s Withholding Allowance Certificate. It needs to be completed before running your first payroll for the employee. A W-4 identifies how much money will be withheld from an employee’s paycheck for federal, state, and local taxes.
Whenever you hire a new employee, they must complete a W-4 form. They can then update their W-4 at any time, based on changes to their personal or financial situation. If an employee is unsure about how much pay to withhold, they might find the IRS Online Withholding Calculator helpful.
What are the key elements of a Form W-4?
A Form W-4 is pretty basic. It includes a series of questions for your employee to fill out to help them determine the number of allowances they want withheld from their paychecks. The information the employee will provide includes:
- Name and address
- Social Security number (SSN)
- Filing status — single, married, or married filing separately
- How many allowances they plan to claim
- Additional money, if any, they may want to have withheld from their paycheck
On the last three lines, you, as the employer, enter your name, address, employer identification number (EIN), and the employee’s start date with your company. The other three pages of the W-4 are just for your employee’s records and offer instructions to complete the W-4 correctly, including three worksheets:
- Personal Allowances Worksheet
- Deductions, Adjustments, and Additional Income Worksheet
- Two-Earners/Multiple Jobs Worksheet
The W-4 is used to calculate how many “allowances” an employee can claim. The more allowances they claim, the less you withhold from their paychecks. The amount of federal tax withheld is based on the number of allowances claimed on the W-4 and depends on your employee’s situation.
Tax allowances are based on things like:
- Whether they itemize personal deductions instead of claiming the standard deduction
- Whether they can claim the child tax credit for a qualifying child (or a dependent who is not a qualifying child)
- Whether your employee or their spouse has more than one job and what their total income is.
For example, let’s say an employee is single, head of household with one child, and taking the standard deduction. In this instance, the employee can claim one personal withholding allowance, one for his or her child, and a third if he or she is single with only one job.
If employees accurately calculate their withholding allowances, they just might be able to avoid paying a large tax bill when April rolls around. They may also avoid overpaying taxes, so they have more money in their wallet throughout the year.
It may be important to point out to your employee’s that the W-4 worksheets and withholding methods don’t account for all possible situations. For that reason, your employees may not be getting the right amount withheld. This is most likely to happen in the following situations:
- They have more than one job at any one time.
- They are married and both work.
- Their withholding is based on outdated or incorrect information on the W-4 for a substantial part of the year.
- They only worked part of the year.
- They have non-wage income, such as interest, dividends, unemployment compensation, or alimony.
- They change the number of withholding allowances during the year.
- They are subject to additional Medicare tax.
It’s also a good idea to inform your employees that personal exemptions have been eliminated from 2018 through 2025 by the Tax Cuts and Jobs Act. Employees can no longer take them into account when determining withholding allowances.
W-4 state forms
When it comes to new employee forms, the federal Form W-4 is just the beginning. You may also need to collect a state-specific form, including a state W-4 for your employees. Several states, such as Minnesota, Colorado, and Mississippi, use state W-4 forms to determine state tax withholdings. Some states, like Texas, Tennessee, South Dakota, and Florida, have no state tax withholding, so in these states, you don’t need a state withholding form.
Most states, however, do have a form similar to the W-4 for their state tax withholding. For example, in Illinois the form is called an IL-W-4, in California, it’s a DE-4 Withholding Certificate, and in Kansas, it’s a KW-3 Withholding Tax Return. For a complete listing, take a look at state-specific tax forms.
If an employee expects their wages will result in no tax liability, they can claim a W-4 exemption. For example, if the standard deduction for a married couple with one child is $26,400 and your employee is a sole-wage earner and knows he or she will earn less than that, they may want to consider claiming an exemption.
Why the W-4 deserves your employee’s careful attention
The W-4 is important for two reasons. If your employee doesn’t withhold enough tax from their paycheck, they could be on the hook for a big tax bill in April, and possibly even a fine. That’s why correctly filling out the W-4 shouldn’t be taken lightly.
Then again, if too much tax is withheld from their paychecks, their take-home pay will be less, but they could receive a tax refund at the end of the year. Receiving a refund may sound good, but having more money in each of their paychecks gives them the chance to invest it, save it, or use it for something else.
W-4 responsibilities as a business owner
As a business owner, hiring new employees is just part of the job. Making sure each new employee fills out a W-4 should be one of the first tasks you complete. You are responsible for withholding money from your employee’s paycheck that goes toward their income tax liability. The IRS recommends each of your employees submit a new W-4 each year. However, most employees only make adjustments if there’s a change in their personal life, such as getting married or having a child.
Employees can claim allowances for a number of things, such as working only one job, having dependents, or having a significant number of deductions and credits that they are eligible for on their taxes. All of this information is reported on their W-4.
Every allowance claimed by an employee reduces the amount of money that you withhold from his or her paycheck for each pay period. Although uncommon, if an employee chooses not to complete a W-4, the IRS recommends you withhold taxes as if your employee is single and claiming zero allowances.
You are also required to withhold Social Security and Medicare taxes. And because tax rules and regulations change frequently, it’s important for you to stay up to date. As an employer, your life can be made a whole lot easier with an automated payroll service. This can reduce the likelihood of errors, which can reduce the likelihood of penalties from both the IRS and state taxation agencies.
Do independent contractors need to fill out a W-4?
You should have independent contractors or freelancers — sometimes called 1099 employees — fill out a W-9 form instead of a W-4. The W-9 mostly gathers the Social Security number or other taxpayer ID for clients to use when they file with the IRS.
Legally, independent contractors are not employees, and clients will not normally withhold taxes from their paychecks. They are expected, however, to pay estimated quarterly taxes to cover their tax liability. At the end of the year, independent contractors will receive a 1099 form from each of their clients, outlining how much they made. This is the form to include when filing taxes at year end.
What is a W-2?
Form W-2 is called an informational return because it informs your employee, plus the federal, state, city, and local governments about earnings and the amount of taxes your employee paid for the year.
A W-4 informs you how much tax to withhold from an employee’s earned income, while a W-2 is a year-end tax document. It reports information on employees earnings (gross pay, tips, and bonuses), and their contributions to state and federal taxes, Social Security and Medicare (FICA), childcare, and additional withholding such as to savings and retirement.
Any company that pays an employee $600 or more in wages during the tax year, must provide a W-2 to the employee as well as to the IRS. Employees must have their W-2 on hand when they file their taxes in April.
Independent contractors don’t usually receive a W-2. Instead they receive a 1099-MISC.
When is the W-2 due?
As an employer, you have to provide copies of Form W-2 to all employees by January 31 of each year (or face a W-2 filing penalty). You must also submit a copy to the Social Security Administration (SSA). The W-2 will list exactly how much money your employees made the previous year, and how much went to federal income taxes, Social Security and Medicare taxes, and state and local taxes.
Four important steps for payroll processing
Sometimes, to better understand the purpose of both the W-2 and W-4 forms, it helps to understand the payroll process. Broadly speaking, payroll processing requires these four steps:
- Data collection: When an employee is hired, you need to collect information to withhold the proper amount of federal and state income taxes. You may also withhold money to help pay for company-provided benefits.
- Net pay calculations: This is the amount of money employees take home after all deductions have been taken out.
- Payments: You must pay each worker by check or by an electronic transfer to a bank account.
- Reporting: You must report federal and state tax withholdings for each employee to the IRS and state department of revenue. The W-4 is used to collect employee data for tax withholdings, and the W-2 reports total taxes withheld from gross pay for the year.
Taking charge of W-4 and W-2 forms
The W-4 and W-2 are in some ways related, and in other ways completely different. The W-4 is used to gather employee information and calculate how much tax to withhold from their paychecks, and the W-2 is provided to employees at year end so they can file their taxes.
As a business owner, keeping them straight and understanding their differences will not only help your employees make better decisions but also help keep your books in order. And whether you’re a new or growing business, currently hiring employees or just trying to free up the time spent manually entering payroll, it helps to use payroll software to manage the process.