At the heart of every thriving business is a solid grasp of financial obligations, and this includes knowing how to handle your accounting, taxes, and documentation. It's not just about receiving payment, paying your dues, and meeting deadlines—it's about understanding the hows and whys of the process.
But as an entrepreneur or an employee, navigating the maze of IRS requirements can often feel confusing and overwhelming, especially when it comes to understanding the differences between tax forms like W-2, W-9, and W-4 forms. Whether you're a seasoned business owner or employee or just starting out, the chances are that the complexities of the W-9 and W-4 forms in particular have caused you some headaches.
You're not alone. Tax form confusion often stems from their similar appearance and overlapping functionalities. Fortunately, these two forms cater to very different aspects of tax reporting and compliance.
In this blog post, we’ll go over what each form is, compare their differences, and advice on what you should include in each for accuracy. Knowing these details can help you prepare for the upcoming tax season with much more ease and peace of mind.
What is a W-9?
First, let’s look at what a W-9 is. The IRS Form W-9, officially titled Request for Taxpayer Identification Number and Certification, is a fundamental tax document that is completed by businesses, the self-employed, and independent contractors alike. Its chief role is to facilitate the exchange of tax information between parties involved in financial transactions.
The W-9 is the tool by which a business engaging a contractor, freelancer, or gig worker reports the payments made to these individuals or entities to the IRS. This is especially vital for payments classified as "Nonemployee Compensation," which are commonly documented on a 1099-NEC form. The payers have a responsibility to provide the W-9 upon signature of the work agreement, and the payees are obligated to complete it.
Essentially, the W-9 is submitted to a payer by a person or business entity (the payee), who provides their Taxpayer Identification Number (TIN)—which may be a Social Security Number (SSN), Employer Identification Number (EIN), or Individual Taxpayer Identification Number (ITIN)—to ensure accurate reporting of income for tax purposes.
What is a W-4?
The W-4 form, officially known as the Employee's Withholding Certificate, plays a critical role for employees and employers when it comes to employment taxes. Unlike the W-9, which is used primarily by contractors and freelancers, the W-4 is an integral document in tax withholding for people working a traditional job.
The primary purpose of the W-4 is multifold and has many uses:
- Reports income for the year
- Discloses taxpayer information, certifies taxpayer identification number, declares tax status, and determines tax liability
- Guides employers in determining the correct amount of federal income tax to withhold from an employee's paycheck. This amount gets deposited with the IRS throughout the year.
- Gives the IRS an idea of the amount of income tax the employee will owe for the year so they can withhold it incrementally from each paycheck.
- Contributes to Social Security and Medicare via deposit so that employee earnings are properly allocated to these programs. This also ensures compliance with the Federal Insurance Contributions Act (FICA).
Calculating W-4 Withholding
Calculating the withholding based on a W-4 involves a specific IRS formula that reviews tax information and considers the employee's earnings, the frequency of paychecks, and the information provided on the W-4. The amount is based on multiple factors on your W-4, including:
- Your filing status
- Whether you hold more than one job
- Whether or not you have dependents
- Any additional income or tax deductions you expect to have
The purpose? To help employees avoid a large tax bill at the end of the year. It also prevents them from overpaying taxes throughout the year and compares tax information. This allows them to get that big tax refund that we all look forward to at the beginning of each year.
What is the Main Difference Between W-9 and W-4?
The main difference between W-9s and W-4s lies in their intended audience. You can also differentiate the type of form by their tax purposes. The W-9 form is primarily used by freelancers, independent contractors, and other types of non-employees to provide their Taxpayer Identification Number (TIN) to the entities that pay them.
In contrast, the W-4 form is used exclusively by employees to direct employers on how much federal income tax should be withheld from the employee's paycheck. The W-4 is a critical tool for employees to control their payroll taxes and dictate how much money is taken out of their wages throughout the year for tax purposes.
Who Needs Form W-4?
For workers in traditional employment, the W-4 is non-negotiable for compliance with IRS regulations and optimal financial standing. From new hires starting their journey with a company to those experiencing significant life changes, the W-4 form plays a pivotal role in how their tax situation is handled.
The moment you become an employee of a company, the company issues documentation for onboarding. Within these documents, you are required to fill out a W-4 form. It’s a one-time requirement at the start of your employment, but its accuracy is crucial.
Why, you ask?
Well, if a new employee fails to submit a W-4, the employer defaults to withholding tax at the highest rate, assuming single status with no adjustments. This could lead to higher costs and a larger chunk of your earnings being withheld for taxes. Timely and accurate completion of the W-4 ensures that the withholding aligns with your actual tax liability, preventing overpayment or underpayment of taxes throughout the year.
Employees Adjusting Tax Withholdings
There are times when employees may need to adjust their tax withholdings. The employee adjusts withholding based on various factors. For example, they may realize that too much or too little tax is being withheld from their paychecks, affecting their financial planning and tax return.
Employees can resubmit a new W-4 to their employers at any time during their employment when they feel an adjustment is necessary. This flexibility allows them to fine-tune their withholdings in response to changes in their tax situation, such as a secondary income or a discrepancy in previous tax estimations.
Not adjusting withholdings when needed can lead to unexpected tax liabilities or lower-than-expected refund amounts at year's end. Conversely, proactively taking action to manage withholdings via the W-4 can avert these surprises and give you a more balanced financial standing throughout the year.
Employees Experiencing Major Life Changes
Various major life changes can drastically alter an employee’s tax situation, including:
- The birth or death of a child
- A spouse’s job loss
- Becoming a primary caretaker for a family member
In these scenarios, revising the W-4 form is imperative. For example, a marriage may qualify an employee for a different filing status and potential tax deductions like the Marriage Tax Credit. The addition of a child could introduce tax credits such as the Child Tax Credit. The form is requested by the employee, who updates personal information to gain the benefits of these credits.
Failing to update the W-4 after such life events could result in inappropriate tax withholdings and lead to potential issues during tax filing. It can also affect tax refunds or liabilities. Timely updating the W-4 in response to these life changes allows the withholdings to stay in sync with the new financial reality, providing peace of mind and financial stability in the light of altered circumstances.
What is on the Form W-4?
The current version of Form W-4 encompasses various aspects that guide employees and employers to accurately determine tax withholdings. It starts with a set of sections, which is filled out by the employee and verifies taxpayer information. On the bottom, you’ll see a space for the employer to put their name and address, your first date of employment, and their EIN.
The form finishes with a set of instructions that provides information on how to fill out each section and differentiates withholding criteria. You need to fill everything correctly and complete the form to avoid under or over-withholding of taxes. Any misrepresentation or omission can lead to inaccurate withholding, resulting in a potential tax liability or an unexpectedly large tax refund.
Old vs New W-4
The W-4 form, which was last updated in 2020, underwent some changes in October 2023. These updates are subtle, but they’re significant for ensuring accurate and compliant tax practices.
Here are the key changes:
- Removal of Tax Withholding Estimator References: The IRS has removed references to the tax withholding estimator from the form. This change streamlines the form, focusing employees on the current information needed without external estimation tools.
- Updated 2023 Deductions Worksheet: The deductions worksheet has been revised with updated financial information for 2023 so that withholdings are in line with the latest tax guidelines and thresholds.
- Clarification in Step 2(c): Step 2(c) deals with multiple jobs or situations where both spouses are working. It now includes additional text that provides clearer guidance on who should use the checkbox for two jobs, aiding employees in making accurate selections that reflect their employment situation.
It’s important to note that current employees with a valid W-4 on file are not required to complete a new form solely due to these redesigns. Despite that, employers should make their teams aware of these changes.
In addition, the information on the existing W-4 can still be used to calculate withholdings unless the employee needs to update their filing status or adjustments. However, the most recent version of the W-4 should be completed in cases where a new form is required.
What Employees Must Include on Form W-4
When completing the W-4 form, employees are required to provide specific, critical information for accurate tax withholding. The form has five sections of essential elements that must be included:
- Step 1 - Personal information: This includes the employee’s full legal name, address, Social Security Number, and filing status.
- Step 2 - Multiple jobs or working spouse: If applicable, employees need to disclose if they have multiple jobs or if they have a working spouse.
- Step 3 - Dependent Claims: Claiming dependents affects the amount of tax withheld. Employees with dependents, such as children, should accurately report this to benefit from potential tax credits like the Child Tax Credit.
- Step 4 - Other Adjustments: This section allows for more detailed adjustments. It includes other income (not from jobs), deductions other than the standard deduction, and any extra withholding you want your employer to take out of your paycheck.
- Step 5 - Signature: In this final step, the form is signed by you and dated, verifying that the information provided is error-free. Without your signature, the form is not valid.
While all employees must fill out Steps 1 and 5 (personal information and signature), Steps 2 to 4 are optional and contingent upon your specific tax situation.
Who Needs Form W-9?
Now for the W-9 form. This form is essential for those operating outside the traditional employee-employer relationship, such as freelancers and independent contractors. Some other situations may necessitate the form W-9.
If you’re an independent contractor, freelancer, or gig worker who services a business and its customers, you work for someone but aren’t employed by them. In these cases, W-9 forms are your go-to tax documents. The W-9 form is how you give a client the key details they need to report what they've paid you to the IRS. So, whether you're a graphic designer, a consultant, a copywriter, or a part-time coder, this form is an essential part of your financial toolkit.
New Bank or Lending Institution Members
Stepping into the world of banking or borrowing? The W-9 also comes into play here. When you open a new account with a bank or a lending institution, they might ask you for a W-9.
Because any interest or dividends you earn need to be reported, typically on a Form 1099-INT. It's a way for the financial institution to keep things transparent and above board with the IRS, making sure they can report any earnings you accumulate through your accounts.
Property and Debt Transactions
The other party involved may request a W-9 from you in certain types of property and debt transactions, including:
- Mortgage interest payments
- Student loan payments
- Real estate transactions and investments
- Settling certain types of debt
This gives them the necessary information to accurately report any transaction and investment to the IRS, typically using Forms 1098 and 1099.
What is on the Form W-9?
The W-9 form seems pretty straightforward at first glance, but each section plays a vital role in keeping your business or freelance work’s operations running smoothly. It features information on the payer, areas for payees to fill in, and instructions on filling it out. Let’s look at the recent changes made in 2023 and what you should include for accurate and efficient tax reporting.
Old vs New W-9
The W-9 form has seen some tweaks over the years. The pre-2023 version focused primarily on collecting the Taxpayer Identification Number (TIN) from U.S. persons and resident aliens for various reporting requirements. This form was straightforward but lacked specific details for more complex business structures. Non-compliance—such as not providing the correct TIN—could lead to backup withholding, a situation where the payer must withhold tax at a set rate from payments made.
That’s why a notable change was made in the new 2023 revision. A new line 3b has been introduced specifically for flowthrough entities like partnerships and trusts. This line is a game-changer for entities that provide the W-9 to a partnership, trust, or estate and have foreign partners, owners, or beneficiaries. It's designed to streamline the process of identifying and reporting indirect foreign interests in these entities, aligning with requirements for Schedules K-2 and K-3 of Form 1065.
This update brings clarity and specificity to the reporting process, especially for entities with complex structures involving foreign partners. If you’re a U.S. citizen or resident alien, this means better compliance with IRS regulations and smoother handling of international aspects of business taxation.
What Employees Must Include on Form W-9
The W-9 form is straightforward, but each section has its unique significance. Details you must include on your form encompass:
- Lines 1 & 2 - Identifying information: Here, you print your full name and, if applicable, the name of your business. It’s important to put this information exactly as you file your taxes.
- Line 3 - Federal tax classification: This part is where you clarify your business structure. Are you classified as a self proprietorship, a limited liability company (LLC), a partnership, or maybe a S corporation or C corporation? This classification guides how your income is taxed. And don’t forget that with the latest 2023 updates, you have to provide additional details regarding foreign partners or beneficiaries in line 3b if you're a flowthrough entity.
- Line 4 - Exemptions: This is where you declare if your business is exempt from backup withholding or FATCA reporting. In this section, you can place your “exempt payee code” or “exemption from FACTA reporting code”. You can not fill this section out as an individual.
- Lines 5 & 6 - Address & Account Numbers: Your main business address, including the city, state, and zip code.
- Line 7 - Account Number: Many contractors work with multiple companies, or vendors. In those cases, they’ll complete multiple W-9s. The vendor number identifies payer/payee relationship. If this applies to you, you’ll put a unique vendor number in this section to specify which account the W-9 pertains to.
- Part I - Taxpayer Identification Number (TIN): Your SSN, EIN, or ITIN
- Part II - Certification: Your signature and the date signed. This section serves to certify that the information within is accurate and up-to-date.
The rest of the form consists of instructions that help you fill in the form correctly. It’s important to review these instructions to avoid any errors before you.
The W-4 form is used by employees to inform employers how much federal income tax to withhold from their paychecks.
The W-9 form is used by independent contractors, freelancers, and gig workers to provide their Taxpayer Identification Number (TIN) to entities that pay them.
The 2023 revision of the W-4 form removes tax withholding estimator references, updates the amounts on the deductions worksheet, and adds clarifying text for section 2(c).
The 2023 revision of the W-9 form introduces a new line for flowthrough entities like partnerships and trusts to provide information on indirect foreign partners, owners, or beneficiaries.
Frequently Asked Questions
What Are the Consequences of Not Filing a W-9?
Failing to file a W-9 can lead to backup withholding, where the payer legally withholds taxes at specified rates (currently 24% in 2023) from your payments. This can cost you a lot of money, as you could incur penalties or losses in income upfront.
Can You Claim Exemptions on Both Form W-9 and W-4?
On the W-9, you can claim exemptions if you meet certain criteria, such as being exempt from backup withholding or FATCA reporting. However, the W-4 is focused on withholding allowances and adjustments based on personal and financial situations, like dependents or additional income. Exemptions claimed on these forms serve different purposes and are specific to each form's context.
How Often Should You Update Your W-4 and W-9 Information?
You should update your W-4 whenever you start a new job or there are significant life or financial changes, like a change in marital status, the birth of a child, or a change in income. For the W-9, you only update whenever your personal or business information changes, such as a new business name or TIN.
For additional info on the W-4 or W-9 forms, including updated copies of them, you can visit the IRS site directly or use Bonsai’s free online fillable W9 form. For help with taxes, or to experiment with Bonsai's suite of freelance products, sign up for a free trial!
Disclaimer: The information provided is for informational purposes only and is not a substitute for professional tax, legal, or accounting advice. You should consult your own CPA, legal, and tax advisors before engaging in any transaction.