As we enter a new tax year, now is an ideal time to start fresh and adjust your employment tax withholding. Taxpayers frequently make the mistake of setting up their employment tax withholding in a way that will result in a large refund from their income tax returns. Many do this intentionally with the mindset that the overpayment of tax money will act as a savings account of sorts, allowing them to enjoy the bonus refund that they’ll receive after filing their taxes.
Financially speaking, overpaying taxes throughout the year is not the best use of your money, as the IRS does not pay you any interest on the money that they collect from you in overpayments. If this is the case for you, it will likely benefit you to adjust the withholding amount on your W-4 so your tax payments more closely match what your actual tax liability is each year. That way, you’ll neither receive a tax refund nor owe the IRS money when you file your income taxes.
Here are some suggestions on how to choose the best method of income tax withholding in order to receive the smallest refund, while keeping more of your money throughout the year either to save in an interest-bearing account or to invest with:
Federal Income Tax Withholding
When you become the employee of a company, you will fill out a Form W-4, Employee’s Withholding Allowance Certificate, which indicates the number of federal exemptions that you intend to claim. You will also check a box to specify your tax filing status, choosing from Married, Single, or Head of Household. The answers to the questions on the Form W-4 are used to calculate the amount of federal taxes that will be withheld from each paycheck that you are issued. If you choose any incorrect information on your W-4, you may be overpaying in taxes, which results in an income tax refund, or not paying enough, which results in a tax liability when filing your income tax return.
If You Typically Receive a Large Tax Refund
Instead of giving the government an interest-free loan each year, increase the number of personal allowances on your W-4 so that less money will be taken out of each of your paychecks to be put toward taxes each pay period. Invest or save any difference in your pay in a place where the money will earn you interest, instead of allowing government to reap the investment benefits.
Use the IRS Withholding Allowance Calculator
Visit the IRS website and use the interactive withholding allowance calculator to determine what your ideal withholding amount should be. You should revisit the allowance calculator each time you have a major life change that affects your tax situation -such as marriage, divorce, the addition of children to the household, or the purchase of a home. You may also want to consider making adjustments any time that you receive a large refund – or have a large tax liability – when filing your income tax return, as both scenarios indicate that your withholding are not optimized for your financial situation.
Request IRS Form W-4 from Your Employer
Once you have a better idea of how to adjust your employment tax withholding, ask your employer for a W-4 form so that you can change the amount of money that is withheld from each of your paychecks going forward.
Withhold a Specific Dollar Amount per Pay Period
Another option is to request a specific dollar amount to be withheld for taxes from each of your paychecks. If you know how much you will owe the IRS for income taxes, you can divide that amount by the remaining paychecks that you’re planning to receive in the current tax year. For example, if you determine that you will owe the IRS $600 and you have 12 paychecks remaining, you can withhold $50 per pay period. The following tax year, divide the total amount that you owe (above and beyond your regular withholding) by the number of pay periods. In this example, you might divide $600 by 52 weeks and have an additional $11.50 taken out of each paycheck throughout the entire year.