I’m sure most people have heard the terms Tax Withholdings and W-4s. After receiving my tax refund I decided to see how I could adjust my taxes in order to not receive a refund next year. First we need to get everyone on the same page and understand the differences between the terms listed above.
The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year.
As a wage earner, you pay federal income tax by having it withheld from your pay during the year. This is your “withholding.” Your withholding is based on the number of allowances you claim when you file Form W-4, Employee’s Withholding Allowance Certificate, with your employer. (IRS Publication 919)
W-4 is a tax form used by the United States Internal Revenue Service. The form is used by employers to determine the correct amount of tax withholding to deduct from employees’ wages. Ideally, this amount will exactly equal the annual tax due on the 1040 series related to employment compensation, though in reality, many times it is off by a substantial amount. (Wikipedia)
In order to figure out the correct withholdings you will need to gather some information.
- Print this form out from the IRS, How do I adjust my tax withholding
- Have a copy of your tax return handy for reference
- Have a copy of your Schedule-A Itemized Deductions sheet if you plan to itemize
Withholdings using the Standard Deduction
If you use the standard deduction, adjusting the withholdings may not help much. If you are having a child or are caring for a relative, then you can adjust the withholding by 1 for each case. Adjusting more will leave you open to the possiblity of having to pay next April. Use the IRS Withholding Calculator to enter your information to see how it can benefit you.
Withholdings using Itemized Deductions
If you pay mortgage interest, state taxes, property taxes, medical expenses in excess of 7.5% of your income, or have charitable contributions then you probably receive a much larger tax refund. These are all deductions that reduce the amount of taxes you pay resulting in overpaying the govenment throughout the year. In an ideal world the government would take out the correct amount of taxes, leaving you with only a small amount pay back or receive. Having a small amount at the end of the year means you can have extra money each paycheck to help with debt reduction, bills, and even investing. Having the government hold onto money I can use to get out of debt doesn’t sit well with me.
There are a few tools to use to help you understand the correct amount of withholding to claim on your W-4 forms. The first is the IRS Withholding Calculator. The tool requires you to enter a bunch of information. Below is a snapshot of one of the screens.
You will also need some information about itemized deductions. If your pay will remain about the same, use your Schedule-A form from your tax return to enter these values. Example, if you pay state taxes and property taxes add these up and enter the value. Enter the mortgage interest from last year since it will likely be very close to this year. After all the information is entered. The IRS calculator will tell you how many withholdings you should claim.
I was very surprised by the amount of withholdings I should claim for 2010. I have been claiming 4 which has resulted in a large tax refund. After using the calculator, I’m now changing my withholdings to 8. Now that you know how many withholdings to claim how do you figure how much extra money you’ll be getting in each paycheck. Use this calculator provided by Yahoo – How Will Payroll Adjustments Affect My Take-Home Pay? The calculator is very simple to use. Plug in the required values and it will show you the amount of extra money you’ll be getting in your paycheck. It works great and I will be getting almost $300 extra per month. That money will be applied to my debt and help to really make that snowball roll faster down the hill.
The Back Check
I love the ablity to use online calculators and such to make life easier, but whenever taxes are involve I get a little worried. To back check the calculator the IRS has a worksheet that you can manually use to figure out the correct withholdings Worksheet. I used the form and was able to reach the same results. Now that I’ve performed the actions required for me to sleep well at night, it’s time to adjust the withholdings.
The IRS has a W-4 form avaliable online for download: Form W-4 (2010). Most employers use their own form so you need to contact your HR person to locate the correct form to use. Once you have the correct form, just fill it out and send it in. Your employer will make the changes and you’ll see some extra money in 1 to 2 pay cycles.
In the past I’ve read many different articles about adjusting tax withholdings. I followed one of them two years ago. The advice was to add an exemption for yourself, my spouse, my children, and my mortgage. That was 4 at the time. I was still getting a large tax return, so that’s why I dug into the issue. Personal finance and taxes are completely dependant on YOUR situation. Rules of thumb are great, but rarely apply to each person. I hope that you’ll use this information to figure out how to adjust your withholdings. Please seek the advice of a professional if you have questions. Remember that I’m just a pizza delivery guy working his but off to get out of debt. This is just another way to increase the traction required to get out of debt. If you love getting a huge tax return, don’t change a thing. Good luck everyone.