This topic is one of those should be really simple things, that is so far from simple it is absurd. The simplest way to answer it, would be the very basic – it needs to be enough to satisfy the tax impact your earnings create. If you will owe IRS $2,000.00 because of how much you make, you need to withhold $2,000.00 from your paycheck. Sadly, no one knows how much they will make exactly this coming calendar year (unless you have magical powers) and thus cannot know exactly how much to withhold. You do however have a tax return from last year you can reference, and plan from.
I would like to first, however, talk about withholding in general. This is arguably the MOST impactful number in the entire tax return. More important than deductions, more important than anything. If I were to describe the tax return in words, it would be your income of ‘A’ creates a total amount of tax which is ‘B’. You then simply compare ‘B’ to how much you already paid which is ‘C’. ‘C’ is the amount that was taken out of your gross check and sent to the United States Treasury, and why seeing the gross check vs your net check makes you sad and angry at the same time. The difference between ‘B’ and ‘C’ is either your refund or balance due. It really is that ‘simple’.
If you owe taxes to IRS every year, there are a small variety of things you can do to help reduce your tax burden less year. However, the way to spend the least amount of dollars to reduce your tax bill in leaps and bounds, is to increase your withholding on your paycheck. If you withhold an extra $500.00 over the whole year, you will owe $500.00 less. It is dollar for dollar. Putting money into retirement helps, deductions help… but neither are on a dollar for dollar scale. It may take $2000.00 in contributions to your 401k to make a $500.00 change in tax versus making a $500.00 change to withholding to make a $500.00 change to your tax bill. No one likes to hear it, but that is the simple and honest truth.
The topic at hand is determining how much to withhold from your paycheck. It is based on a lot of information. How much income do you have? What other income do you have? What deductions do you have? Are you married? Does your spouse work? Do you have kids? Anyone in college? Do you put money to retirement outside of your paycheck? The list doesn’t end there. The best way to determine how much your paycheck needs to withhold, is based on your last years tax return. Where were you last year for tax purposes? Did you owe money? Did you have a big refund? What needs to be different? If you owed money, your withholding on your paycheck needs to increase. If you got a big refund and would rather have access to those funds during the year, you need to reduce your withholding.
The way to change the withholding on your paycheck, is on the form W4. https://www.irs.gov/pub/irs-pdf/fw4.pdf
Don’t be intimidated by all the information on the pages. The bottom of the first page is the actual form. The rest is just information. You can read it all or just read this blog.
- Boxes 1 and 2 of the W4 is your vital info – fill it in.
- Box 3 is what looks like your filing status, but don’t be fooled. Box 3 determines what math tables your payroll or HR is going to use when calculating your withholding – that is all. The W4 doesn’t dictate the filing status of your tax return. Single is a higher, Married is lower. Married but at the higher single rate, is equal to Single. The 3rd box is what you would check if you are legally married but need your paycheck to be withholding tax at a higher rate.
- Box 5 references allowances and a worksheet. You can do the worksheet if you wish, you do NOT have to. 0 allowances, means withhold at the highest rate on the table you just told payroll to use (single, married, or married at the single rate). This is a percentage of your pay and will scale as your income scales – which is a good thing. The higher the number you put in box 5, the more you are saying you are exempt from tax. It will lower the amount of tax being taken from your check and increase how much you get on your net paycheck. Please do not make the mistake of putting too high a number here, it will reduce your tax withheld to a very small amount and you are at a much higher risk of owing money to the IRS come April 15. As the worksheet goes A-G, the allowances shouldn’t really go higher than 7. Really any allowances after 4 or 5 mean almost nothing coming out of your check for federal withholding. Social security and medicare tax is a flat amount and you are not able to change that ever.
- Box 6 is a special box. It allows you to add a flat dollar amount per paycheck to withholding. It is a number you can calculate with exactness and know exactly how much more will come out of your paycheck. It can be a very handy tool. The catch is that it does not scale as your pay scales and will need to be modified each time you have an increase in pay.
- Box 7 is a box that should have a big HAZARD DANGEROUS MATERIALS INSIDE label on it. Don’t fill this in without consulting with an older wiser person, preferably one who sits atop mountains dispensing sage advice for those willing to brave the elements seeking such wisdom. It can be effective for taxpayers in unique situations – such as a child in college making a couple thousand dollars all year.
In the end, what are your particular needs? Everyone’s needs are different. What do you need to change on your W4?
Do you need to increase your withholding because you owe year to year?
Lower your allowances in box 5, and or change to single / married, but withhold… in box 3
Do you have too much of a refund and want to keep some during the year?
Increase your allowances in box 5 of the W4, do the opposite of the above question
I just started a new job, what do I put down?
What did you put down at your last job? You likely need to at least the same, hopefully the new job is a higher paying job and you need to increase your total withholding a little bit.
I have no idea what I’m doing or how to read a tax return, why won’t you just give me an answer?
Single with 0 allowances on line 5. Sign and return to HR.
Senior Tax Professional