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 if you receive compensation through payroll.
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. 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).”
Some people may prefer to over-withhold during the year and get a refund each tax 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 have questions regarding your withholding calculations, you may also contact your CPA to make sure all items are taken into consideration to determine the correct number of deductions to claim.