In the United States, Form W-4, Employee's Withholding Allowance Certificate, is used by employers to determine the amount of federal income tax that will be withheld from an individual taxpayer's paycheck. The amount of the withholding is linked to the amount a taxpayer expects to receive from the child tax credit, explained in Publication 972.
The Internal Revenue Service (IRS) requires that employers in the United States obtain Form W-4 from employees. Employees are required to indicate, on the form, the number of "allowances" they expect to have during the tax year. Allowances are a concept that only exist for withholding purposes and are used to compute the amount of federal withholding tax the employer will withhold from each paycheck of the employee. The fewer the number of allowances, the greater the amount of withholding.
Child Tax Credit Overview
The child tax credit is a tax credit for low- and middle-income taxpayers allowed under the Internal Revenue Code. The child tax credit allows the taxpayer a $1,000 reduction from tax for each qualifying child age 16 or younger at the end of the tax year. In order to qualify, each child must meet six requirements: age, relationship, support, dependent, citizenship and residence. The amount of the child tax credit is phased out and eventually eliminated for higher income taxpayers.
Child Tax Credit on Form W-4
The IRS allows taxpayers to claim two allowances on Form W-4 for each child the taxpayer feels will fully qualify for the child tax credit. Form W-4 refers the taxpayer to Publication 972, Child Tax Credit, so that the taxpayer can ensure the child qualifies under the age, relationship, support, dependent, citizenship and residence tests. In practice, the vast majority of children age 16 or under qualify under these tests as long as they may not be claimed by another taxpayer. As a result, children qualifying for the child tax credit can greatly reduce the amount of withholding from a taxpayer's paycheck.
Form W-4 uses allowances as a rough estimate of the necessary withholding allowance. Taxpayers who overestimate their allowances or who have a large amount of income outside employment, such as from investments, may have insufficient income withheld from their paychecks. As a result, these taxpayers may not only owe the IRS at the end of the year, but they may be subject to IRS failure-to-pay penalties and interest charges. Higher income taxpayers who have calculated allowances assuming they fully qualify for the child tax credit only to find the amount of their credit has been phased out or eliminated are at particular risk of this.