Significance

• The employee's W-4 aids the employer in determining the amount of federal income tax to withhold from her paycheck. Federal income tax withholding largely depends on the employee's filing status and allowances, as stated on the first page of the W-4. Each allowance gives the employee a certain figure, which lowers her taxable income.
  
  The employee completes the second page of the W-4 only if she plans to itemize her deductions, such as home mortgage interest and charitable contributions, or claim specific credits or wage adjustments. This page also includes a worksheet that the employee completes if she has multiple jobs or if she and her spouse both work and their combined earnings is more than a certain amount.
  
  

Employer Rules

• The employer is required to give new employees a W-4 form to complete. Each employee's situation is different; therefore, it uses the W-4 specific to the employee to determine federal income tax withholding. If the employee fails to submit a W-4 form, the IRS instructs the employer to withhold at single with zero allowances -- the highest tax category.
  
  An employer should not accept an invalid W-4 form from an employee. It should instead return the form to the employee and request a valid one. An invalid W-4 is one that has been altered in an authorized manner such as if the employee claims exempt but also claims allowances.
  
  

Employee Rules

• The employee should complete the W-4 form as accurately as possible. This includes claiming the correct number of allowances, filing status and additional income tax to be withheld from each of his paychecks. He should read the W-4's terms for claiming exempt to ensure he qualifies for exempt before claiming it. Exempt means that he is excluded from paying federal income tax.
  
  

Calculation Process

• The employer uses the employee's W-4 form -- specifically, her filing status and allowances -- and the IRS' withholding tax tables (Circular E) to figure federal income tax withholding. The Circular E's wage bracket and percentage methods gives the amount of tax to withhold based on the employee's filing status, allowances, pay period, and income. The amount allowed per allowance is deducted from the employee's gross wages -- the result is her taxable income. Therefore, the more allowances she claims, the less taxes she pays.
  
  

Considerations

• The IRS can charge employees a $500 penalty for submitting a false W-4. The employee should complete a new W-4 form whenever his financial and personal situation changes. He can use the IRS withholding calculator to determine if he needs to submit a new form. The calculator helps him to avoid overpaying and underpaying federal income tax.