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When you do work or contracting for an employer, you are expected to fill out a W4 form or a W9 form. A W4 form is for people who are considered employees of a company, while a W9 form is for self-employed people or businesses providing services to another company. One of the most confusing questions on both forms has to do with choosing your withholding status. On a W4 form, you have more choices as to how much taxes you want taken out upfront. On the other hand, as long as you do not owe back taxes and working under a W9, you won't have upfront taxes taken out of your pay.
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On a W4 form, you will be asked how many exemptions you wish to claim, or if you want to claim yourself exempt from tax liability. Most people put the number of exemptions as the number of dependents they have in their family, including himself or herself. However, you can claim on the form you are exempt from tax liability. However, this does not mean you will not have to pay taxes at the end of the year.
If you are expecting to invest heavily into retirement accounts, have significant medical deductions, a lot of mortgage or student loan interest, or other deductions, you may wish to write exempt when asked. Keep in mind you must still pay Social Security taxes through deductions from your pay. Remember that if you can get tax refunds if too much tax is taken out, but must pay your tax bill if not enough taxes are taken out of your checks.
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Self-employed people doing contract work for a company do not have taxes taken from their pay upfront, unless they are subject to backup withholding. This is when 28 percent of even W9 pay is taken out of each check, and is usually reserved for those who owe back taxes. It also can be enforced if your name and Social Security Number do not match IRS records. The good news is this is rare, and if backup withholding applies to your financial life the IRS will notify you.