During this past tax season some people received large refunds while others owed underpayment penalties on top of additional taxes owed to the IRS. To avoid this next year, you might want to consider adjusting your income tax withholding on your W-4 Withholding Allowance Certificate.
But how do you determine the optimal tax to deduct from each paycheck? The IRS provides a withholding calculator that does the work for you. Simply follow the steps and enter the results on your W-4. The IRS suggests the following taxpayers may benefit:
- Employees who would like to change their withholding allowance to reduce their tax refund or their balance due;
- Employees whose situations are only approximated by the worksheets on the paper W-4 (e.g., anyone with two jobs or marriages in which both are employed; people entitled to file as Head of Household; and those with more than one child eligible for the Child Tax Credit); and
- Employees that have non-wage income more than their adjustments and deductions, who would prefer to have tax on that income taken from their paychecks rather than make payment arrangements through the estimated tax procedures.
The IRS further advises, “If you think you will be subject to the alternative minimum tax (AMT), self-employment tax, or other taxes, you might achieve more accurate withholding results by following the instructions in Pub. 505 (Tax Withholding and Estimated Tax).”
Here is an example of how this would apply:
Suppose John is a joint filer, earns a salary of $150,000, has two dependents, and has yearly itemized deductions of $10,000. The taxpayer currently has income tax of $1,500 withheld from their monthly paycheck (i.e., $9,000 halfway through 2015).
Based on the information entered into the calculator (without other factors), the anticipated income tax for 2015 is $23,938. If John doesn’t change the current withholding arrangement, $18,000 in income tax will be withheld for 2015, leaving $5,938 due when he files his 2015 tax return. To meet the actual tax liability of $23,938, John could change the current withholding arrangement by claiming 0 allowances and adding the extra amount of $1,469 towards the balance.
As you can see, this tool provides a bull’s–eye number to target. Some people may prefer to over-withhold during the year and get a refund each tax return season, even though this is effectively giving the government interest-free use of their funds. It could be considered to be a forced method of saving that works for them. These taxpayers can choose to stick with their current withholding setup, but the calculator can still be used to calculate the expected refund.
If you’d like more information on this topic or others related to taxes, more posts can be found on our site abandp.com/blog.
