Are you ecstatic when you get your tax refund each year? Do you feel like you’ve hit the jackpot when Uncle Sam sends you a huge check? Well, getting a giant refund at tax time may not be such a good thing after all. It means that you’ve been withholding too much tax from your pay throughout the year, giving the government an interest free loan and possibly leaving yourself short on cash every month.
Why Would Too Much Tax Get Withheld?
Tax is withheld from your pay by your employer based on an IRS form you fill out called a W-4. This is generally filled out when you first start your job, and many people never update the form to reflect their current circumstances such as marriage, divorce, and the birth of children. Withholding is also based on a full years’ worth of work, so if you start a job midyear, the tax may not be withheld correctly unless you ask your employer to use the Part-Year Method of Calculation (see IRS Publication 505 for more information).
How Do I Know if I’m Withholding the Right Amount of Taxes?
First of all, take a look at last year’s tax return. If you had a very small amount refunded to you and you’ve had no major lifestyle changes (new job, home purchase, change in marital status, birth of a child), then chances are your withholding is pretty close to where it needs to be. But if you got a sizeable refund (or you owed), or you’ve had some changes in your life such as the ones mentioned above, then it’s time to adjust your withholding.
How Do I Figure Out How to Adjust My Withholding?
The first portion of the W-4 form is a personal allowance worksheet. The more allowances you claim on the form, the less income tax that will be withheld by your employer. In addition to the worksheet, the IRS has an online withholding calculator. You will have to have your latest pay stub and your last year’s return handy, and then you will have to answer a series of questions about your filing status, income, credits and deductions. Kiplinger’s has a much less complicated calculator that only asks three questions, but gives you a much less detailed result.
How Do I Change My Tax Withholding?
Once you’ve figured out the number of allowances you should be claiming, you can go to your employer and adjust your W-4 accordingly. It’s important to note that if you use the calculator very close to the end of the year and are going to have a large refund, the IRS will suggest you change your allowances to have no tax withheld. If you go ahead and adjust your W-4 so that no more withholding is being taken out for the remaining months of the year, make sure you re-evaluate your W4 again at the beginning of the next year so that sufficient taxes are withheld.
By taking a look at least once a year at your withholding, and comparing it to your tax return, you should be able to avoid paying excess taxes, keeping your money in your pocket (or at least an interest-bearing savings account!), right where it should be.