Whether you’re a business owner or employee, payroll tax forms have a direct impact on your tax liability. Two forms are critical when evaluating your tax situation for the current year: IRS Form W-4 and IRS Form W-2. These two documents tend to cause confusion, especially for company owners who just opened their first business or workers who are starting a new job. Although these two forms sound similar, their functions are quite different.
The W-4 is an Internal Revenue Service form that employers use to collect personal information from their employees and to calculate how much tax to withhold from employee paychecks. The W-2, on the other hand, reports income tax withholding figures to the IRS, informing the IRS of the amount of tax withheld from an employee’s income.
Understanding the differences between the two forms and how they impact you will go a long way toward ensuring you remain compliant with tax law. Filing the forms correctly the first time can help you avoid lengthy delays and possible penalties. Below, we’ll take a closer look at W-4 and W-2 forms to help you get a better understanding of what to expect.
What is a Form W-4?
The W-4 is a tax form that’s also sometimes called the Employee’s Withholding Allowance Certificate. You can find the form on the www.irs.gov website. New employees will complete a form upon hire. If their personal or financial situation changes, they can update their W-4 at any time by submitting a new form to their employer. Employers need to process this form before paying the employee for the first time.
Employees use the Form W-4 to determine allowances. The number of allowances is used to determine the dollar amount of taxes withheld from the employee’s paycheck. Employees can also document any exemptions from tax withholding requirements on the W-4 form. Below, we’ll take a look at some of the elements that make up the Form W-4.
Key elements of the Form W-4
A Form W-4 includes a series of questions for your employee to fill out to help them determine the number of allowances to withhold from their paycheck. The information the employee needs to provide includes:
- Name and address
- Social Security number (SSN)
- Filing status or marital status — single, married, or married filing separately
- How many allowances they plan to claim
- The additional amount they wish to have withheld from their paycheck
- Whether they’re exempt from having to make tax payments
The employer must complete lines 8-10 at the bottom of the form. Here, you’ll enter your company name, address, employer identification number (EIN), and the employee’s starting date.
Employees and employers only need to process the first page of the W-4. The otherpages of the W-4 include instructions and worksheets to help:
- Personal Allowances Worksheet
- Deductions, Adjustments, and Additional Income Worksheet
- Two-Earners or Multiple Jobs Worksheet
W-4 allowances and additional deductions
Employees use this worksheet to determine how many “allowances” they can claim. The more allowances they claim, the less they’ll pay in federal taxes. Tax allowances include things like:
- If they itemize personal deductions or claim 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 the employee or their spouse has more than one job and their total income earned
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 (a dependent), and a third for the head of household status.
Employers should stress to employees the importance of accurately completing the Form W-4. Withholding too little tax results in a large tax bill at the end of the year. Withholding too much tax provides the IRS with an “interest-free loan” in a sense. If an employee withholds too much tax from payroll, the worker will receive a tax refund when filing taxes the next year. However, the employee won’t have access to those funds during the current year. Having cash on hand in the present is good, as employees can invest the money, save it, or pay down debt.
It may be important to point out to your employees that the W-4 worksheets and withholding methods don’t account for all possible situations. The IRS Online Withholding Calculator can help employees more accurately determine how much to withhold from their paycheck. Employees may want to consider some of the following circumstances when determining how much to withhold:
- 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 an additional Medicare tax on earnings.
Employees should also remember that the Tax Cuts and Jobs Act eliminated personal exemptions from 2018 through 2025. During the ‘18 to ‘25 tax years, employees can no longer consider personal exemptions when determining withholding allowances. Now, standard deductions apply to all filers. The 2019 tax year deductions are:
- $24,400 if married filing jointly or a qualified widower
- $18,350 if you’re the head of household
- $12,200 if you’re single or married filing separately
W-4 state forms
Employers must also make sure that employees complete state-specific W-4 forms as well. Remember that employees must pay both federal and state taxes in most states. A state-specific form determines tax withholding at the state level. States don’t necessarily refer to these forms as “W-4” forms, though. For instance, California refers to it as a DE-4 Withholding Certificate. In Kansas, it’s a KW-3 Withholding Tax Return.
W-4 forms and independent contractors
The W-4 Form only applies to employees. If small business owners elect to hire self-employed individuals or independent contractors, they’ll need to concern themselves with IRS Form W-9 and 1099s.
The W-9 is similar to the W-4 in that it gathers necessary information like the worker’s (or business entity’s) name, address, and taxpayer ID. The employer will use this information to inform the IRS about how much they paid the individual for their services. The Form W-9 does not include withholding or deduction information since the employer is not obligated to withhold taxes.
At the end of the year, independent contractors will receive a 1099 from each of their clients, stating how much they were paid. The independent contractor is responsible for paying the entire tax burden on these wages. Independent contractors must pay all income taxes, and both the employer and worker’s portion of Social Security and Medicare taxes.
This is noticeably different from an employee. Not only does an employer withhold taxes from an employee’s paycheck, they also pay half of the employee’s Social Security and Medicare taxes.
W-4 responsibilities as a business owner
Hiring employees is a big responsibility. Many new business owners don’t understand how much maintenance and compliance is associated with doing so. Owners must make sure that each new employee fills out a W-4 so that they can fulfill their responsibility of withholding money for the employee’s income tax liability each pay period.
The IRS recommends that employees submit a new W-4 each year. Although uncommon, if an employee chooses not to complete a W-4, the IRS suggests you withhold taxes as if your employee is single and claiming zero allowances.
As an employer, your life can be made a whole lot easier by an automated payroll service. Using one of these services reduces stress for you while also cutting back on the likelihood of mistakes. Payroll services and reliable accounting software can go a long way toward ensuring compliance with federal and state tax laws.
What is a Form W-2?
The IRS Form W-2 is an informational return. It’s also known as a Wage and Tax Statement. This is the year-end form that employers use to report earnings and the amount of taxes withheld to the IRS. Employers will submit a Form W-2 for each employee that they paid throughout the year.
So, the W-4 instructs employers how much to withhold from an employee’s earnings. Then the W-2 is a summary of how much was paid and withheld throughout the last year.
The W-2 reports information on employees earnings (gross pay, tips, and bonuses), and their contributions to federal taxes, Social Security and Medicare (FICA), and any additional withholdings such as retirement plans. Both the IRS and the employee will receive a copy of this completed form. The employee will use the form to file their year-end taxes.
Employers must provide copies of Form W-2 to all employees by January 31 of each year. Otherwise, they face a W-2 filing penalty. They must also submit copies to the IRS and Social Security Administration by this date.
Much like the W-4 form, W-2 forms also exist at the state level. Employers are responsible for informing their respective states how much employees earned during the previous tax year. Employers must understand that federal income tax and state income tax are different payments, and that they need to file a Form W-2 to both entities.
The payroll process and how it relates to W-4 and W-2 forms
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 accounting for all deductions
- 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 your state’s 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.
Take charge of your payroll by understanding W-4s
The W-4 and W-2 are in some ways related, and in other ways completely different. Employers should use the W-4 to gather employee information and calculate how much tax to withhold from employee paychecks. Employers then submit the W-2 to the IRS and employees by January 31 of the following year in order to report wages and taxes withheld.
As a business owner, understanding their differences and filing processes will go a long way toward ensuring compliance. Being compliant with tax law helps both you and your employees. Be sure to check your tax-filing procedures to make sure you’re doing things correctly and consult a tax professional should any issues arise.