Are Your Tax Withholdings Correct?
If you are employed, your taxes are most likely collected on a pay-as-you-go basis, meaning a little bit is withheld from each paycheck. It is assumed that it is easier and less painful to pay small amounts throughout the year than to pay one huge bill once a year. However, the amount of taxes that is withheld from our paychecks is often different from our actual tax liability, which is why some people get refunds, because their withholdings are more than their liability, and some people owe, because their withholdings are less than their liability.
Avoid large refunds and bills
Increasing your take-home pay and having more money to pay bills may sound nice, but you want to avoid having so little in taxes withheld from your paycheck that you wind up having to pay a heap of cash come April 15. It is best to break even – neither owe nor get a refund. Of course, it can hard to have your withholdings exactly match your liability, but if the amount you receive or owe is consistently large, it may be time to make a change.
Form W-4 is available on the IRS’s website at www.irs.gov. It contains three sections that allow you to determine your withholdings: the Personal Allowances Worksheet, Deductions and Adjustments Worksheet, and Two-Earners/Multiple Jobs Worksheet. The more allowances you claim on the form, the less is withheld from your paycheck for taxes.
Personal Allowances Worksheet
Deductions and Adjustments Worksheet
While deductions, adjustments, and credits all reduce the taxes you need to pay, they work differently. Deductions are expenses you can use to reduce your taxable income. Examples of deductions include mortgage interest, property taxes, charitable contributions, and, to a certain extent, medical expenses. On your tax return, you can choose either the standard deductions, a specific amount set by the IRS, or the itemized deductions, what your expenses actually are. Adjustments lower both your taxable income and your adjusted gross income, which is used to determine whether you qualify for certain tax benefits and how much you can claim for some deductions. IRA contributions, alimony payments, moving expenses (in some circumstances), and student loan interest payments are common adjustments. Credits reduce the amount of taxes you need to pay dollar for dollar. Credits are given for, among other things, paying for childcare, having children, paying for college or adult education, having income beneath a certain limit, and adopting.
When you fill out the worksheet, you will have to put down specific amounts for your deductions, adjustments, and credits for the year. You may already know what they are, or you may have to do some research or estimate. For expenses you cannot be certain of until the end of the year, such as medical costs, try to be conservative. If you overestimate, you may wind up owing. If you are claiming credits, you will need an additional form, “Converting Credits to Withholding Allowances”, to figure out what to put on your Form W-4. It is available on the IRS’s website. Since taxes are not collected on a pay-as-you go basis for non-wage income, such as dividends and interest, if you have any of this income, it is recommended that you subtract it from your deductions, adjustments, and credits, to avoid claiming too many allowances. Once you fill out the worksheet, it will tell you if you have enough deductions, adjustments, and credits to claim more allowances.
Two-Earners/Multiple Jobs Worksheet
Filling out your Form W-4 so that your paycheck withholdings correspond to your tax liability may be time-consuming, but it can help you to avoid “lending” or owing the IRS a lot of money. Still, Form W-4 is only a guide – it cannot guarantee that your withholdings will exactly match your actual tax liability, especially if your situation changes during the year. Having savings makes paying periodic and unexpected expenses, such as tax bills, easier. If adjusting your withholdings results in a higher take-home pay, why not put that extra money in savings?
*This publication is only intended to be used for general informational purposes. Consult a tax professional for personal advice.
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