We have defended hundreds of taxpayers for delinquent taxes over the years. One very common mistake that launches taxpayers into huge IRS debt is failure to have the employer withhold the right amount of taxes from their paycheck. This tax season is coming to an end. If you have not had the right amount of taxes withheld from your paycheck this year you may owe taxes, and possible penalties and interest, at tax filing time. You can make adjustments to your withholding for the next three months. Notably, adjustments made later in the year will have less impact on your taxes for that year, but better late than never, right? There may be limited benefit to adjusting withholdings for 2015, but making adjustments now will definitely get you off to a good start for the 2016 tax year. The key to proper withholding is to determine the correct amount of allowances on your W-4.
The more allowances you claim on your W-4, the less income tax will be withheld. Conversely, the less allowances claimed, the more tax is withheld. For example, if you claim zero allowances the maximum amount of tax will be withheld. This may get you a big refund, but you are letting the government use your money (interest-free, I might add) instead of investing and earning interest on that money for yourself. The goal is to estimate the right amount of withholding so that at the end of the year, you neither owe, nor are owed by the IRS. It is a delicate balance. The W-4 allowance is very straightforward for the taxpayer who files single, has one job, and claims a standard deduction. However, if you have a working spouse or more than on job, or you get married, divorced, or have a new dependent, figuring the total number of allowances so that withholdings correspond to your tax liability is slightly more complicated.
Anatomy of Form W-4
The W-4 is comprised of three parts: personal allowances, deductions and adjustments to income, and two earners/multiple jobs. They correspond to the Form 1040 so the more the information on the W-4 matches what you report on the 1040, the more accurate the withholdings and the less likelihood of surprises at tax time. Each part is explained below.
Personal Allowance Worksheet – This part of the W-4 is used to calculate 1) your tax rate and 2) income before deductions and adjustments. Most people think they only need to claim the same number of personal allowances on the W-4 that they will claim as exemptions on the Form 1040. This is a common misconception. Number of exemptions is one component of personal allowances. The other component is tax rate, which is determined by your marital status, or whether you file as head of household.
- Tax rate – Your tax rate is determined by the tax table that applies to your filing status. Married people receive the most favorable tax rate, followed by head of household. Single filers and married filing separate have the worst tax rate.
- Exemptions – Taxable income is reduced by a certain amount ($3,950 for 2014) for each exemption. You can claim an exemption for yourself, your spouse and your dependents. A dependent could be a new baby or other new household member that you support.
Deductions and Adjustments Worksheet – This part of the W-4 is intended for people who itemize deductions, have adjustments to income, and/or claim credits. It is used to determine reductions to income which reduce your tax liability, preventing excessive withholding.
- Deductions to income – Deductions are expenses that reduce taxable income. Taxpayers may choose to take the standard deduction or itemize the actual amount of their deductions, whichever is higher. Mortgage interest, charitable contributions and medical expenses are examples of itemized deductions. You will need to know how many itemized deductions you expect to claim or you can estimate based on last year’s tax return.
- Adjustments and Credits – IRA contributions, alimony payments, and student loan interest payments are common adjustments. Credits are given for childcare, having children, paying for college or adult education, having income beneath a certain limit, and adopting. Again, refer to last year’s tax return for the amount. If the amount has changed, you can estimate.
Two earners multiple jobs worksheet – If you have a working spouse and/or you have more than one job, claim all allowances using only one Form W-4. Your withholding will usually be the most accurate when all allowances are claimed on the highest paying job and zero allowances are claimed on all others.
The Bottom Line
The goal is to withhold the right amount of taxes to fit your tax situation. Determine if there are factors that raise or lower your tax liability, like a change in taxable income, being subject to a higher/lower tax rate, and number of exemptions. Factors that reduce tax liability means decreasing withholding by increasing allowances. Factors that increase your tax liability means you will need to increase withholding by decreasing allowances.
If your status changes during the year, such as a new salary, or additional job or your spouse starts or a new job or stops working, you can use the IRS calculator tool to determine how to revise your W-4 based on the number of pay cycles left in the tax year and other factors.
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- 7 Jan, 2017
- suzette blackwell
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