Jun 28, 2021

W-2 Vs. W-4: What’s the Difference?

There’s only a subtle difference that distinguishes the name of Form W-2 from the name of Form W-4. But if you don’t think a single digit can be substantial, talk to the person who has a lotto ticket that reads 3-19-27-37-2 when the winning number is 3-19-27-37-4.

You’d experience a similar degree of frustration if you were to attempt to use a W-2 and W-4 interchangeably. The IRS would have little sympathy for those who argue that their forms are too similar to distinguish. Numbers matter. And when it comes to dealing with financial details, numbers take on an even higher level of importance.

Understanding W-2 vs. W-4

The IRS makes hundreds of different forms and schedules available to American citizens. It’s your job to understand their relevance and ensure you’re using the right ones for the job.

When it comes to the W-2 vs. W-4, the big differences are who completes them and when. Despite the larger number, the W-4 comes first. Your employees will fill it out upon getting hired (or at some other point in their employment) to determine the amount you should withhold from paychecks to cover their taxes.

The W-2, on the other hand, is the employer’s responsibility. This form is filed with the IRS annually to document each employees’ withholdings. A copy of the W-2 is also sent to employees so they can understand their tax situation and take care of any required payments.

How to Fill Out W-4 Forms (And Why to Do It)

Have you ever attended the reading of a will? I haven’t, but I imagine it would be something like in the movies. I’d be standing in a stuffy, old attorney’s office with a group of strangers. As the attorney slowly removed the will from a manila envelope, we’d all lean in closer to learn whether or not we would be inheriting a fortune.

Just as a will outlines how money will be dispersed once someone dies, a W-4 outlines how withholdings will be dispersed each year while they’re employed. While your business and the IRS likely won’t be anxiously attending the reading of a W-4 in an attorney’s office, both parties will be interested in the document, as it informs you of the amount of money that will be withheld for the IRS from each paycheck.

If IRS paperwork came with universal formulas, there wouldn’t be any intrigue surrounding how to fill out W-4 forms. Everyone involved would know exactly how the withholdings would be handled. But we don’t live in a homogenous world—each of your employees will have their own priorities and needs, so they’ll also be required to have a unique W-4.

For example, you might have an employee who loves getting a big tax return each year. That individual would likely opt to have significant withholdings on their W-4, ensuring that they won’t owe money in the coming tax season.

On the other hand, another employee might have big plans for using their paychecks. Rather than wait for an annual tax return, they would choose to withhold a limited amount so they have the maximum cash on hand each month for investing.

Because situations change, it’s advisable for your employees to review their W-4 annually to see if changes need to be made. You should also note that the form is updated from time to time, necessitating a careful review.

“The IRS has introduced a new Form W-4 that must be used by all employers in 2020 to better accommodate recent changes to the tax law,” advises a tax document report from the Los Angeles Times. “The overhaul of the form is the biggest in decades and makes a once-quick exercise a bit more involved. In return, according to the IRS, it will yield more accurate results. That is particularly important as the new tax law led to surprises for some folks last year, due in part to inadequate withholdings. So the new form is worth a look, regardless of how long you have been on the job. The more accurate your W-4, the more accurate your withholdings are.”

As an employer, make sure that each employee completes their W-4 accurately. Don’t let them treat it with an “out of sight, out of mind” mentality. You’ll also need to have systems in place to ensure that the financial instructions in the form are followed perfectly by your payroll staff.

A Closer Look at the W-2

Let’s assume that you handle your employee’s paychecks perfectly throughout the year. You’ll then need to provide them with a document that confirms how their pay was handled. A copy of this form will also be sent to the IRS.

“What is a W-2 form?” asks tax expert William Perez. “Earnings are reported to the recipient, as well to the IRS, on a series of informational forms each year. The W-2 is used only for employee earnings from which taxes have been withheld. It informs employees of the income they must claim on their tax returns and the payments they’ve already made. It also advises the IRS how much income the employee should be claiming and confirms what they’ve paid in taxes.”

The W-2 form should be representative of your employee’s total pay. This means that tips or bonuses will also be included. It will also record how much income you withhold to cover Medicare taxes, Social Security, or other obligations.

Maybe you’re not sure whether or not you’ll need to prepare a W-2 for someone. Here are some simple questions to ascertain if they’re an employee who would get a W-2 or a contract worker who would receive a 1099:

  1. Did you withhold income from the individual’s wages?
  2. Did you withhold Social Security from the individual’s wages?
  3. Did you withhold Medicare tax from employees’ wages?
  4. Did you pay the individual more than $599 in wages?

If you answer yes to 1 or more of these questions, then the individual is likely an employee and you’ll need to prepare a W-2. You can find robust instructions from the IRS by clicking here. Be sure to consult with a financial professional any time you have questions in the process.

About the author

Grant Olsen
Grant Olsen
Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.

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