A Complete Guide on How to Calculate Tax Withholding
- December 17, 2019
- Posted by: BenG-Admin
- Category: Blog, Business, IRS, Taxes, Wage
If you thought that beefy tax refund you got last year was a bonus, you may be in for a surprise.
A hefty refund can mean that you have been handing over a significant amount of your hard-earned money to the government, with each paycheck. The government is only returning the money that was once yours. That is why it is termed as a refund.
However, it could also mean the opposite. Perhaps, you are receiving massive tax bills and becoming tired of sending a big fat check to the IRS every April. Regardless of your situation, the best way to ease your life is take control of your tax withholdings.
What Do You Mean By Tax Withholdings?
Tax withholdings refer to the amount of money your employer keeps aside to cover your taxes. Your employer will deduct this amount from your paycheck. While tax returns are due in April, taxpayers pay bit by bit throughout the year.
The amount of tax withheld from your paycheck depends on two factors:
- The allowances you claim on your W-4 form
- The amount of money you earn each pay period
The more allowances you claim for your spouse, yourself, and your children, the lower your withholdings will be. In case you withhold a large amount, you will receive a tax refund. If you withhold too little, the IRS will send you a bill.
Adjusting withholdings can make you break even at tax time. Put is simply, if taxpayers do not send the IRS a big check, they do not get a huge refund either. According to IRS findings, the average tax refund for this year’s tax season was around $2,725.
Let us suppose you received paychecks every two weeks and got the average fund. You should receive an extra $105 in every paycheck last year. Who wouldn’t mind having $200 more each month?
It is a great idea to closely inspect your tax withholdings so you can make adjustments, especially if you have undergone a major life change. For instance, if you buy a new house, get married, or have a baby, now is the best time to calculate tax withholdings.
Calculating and Adjusting Tax Withholdings
Estimating the amount, you need to withhold from each paycheck can relieve you during the tax season. Surprisingly, it is not that hard to figure out.
Let’s look at some of the steps involved in calculating tax withholdings.
Sum Up Your Tax Withholdings
First, evaluate your projected tax withholdings for the year. Taxpayers can figure out the amount of federal income tax withheld on their paycheck stub. For instance, if you receive payments twice a month and have $150 withheld each pay period, the amount would total up to be $3,600 in tax withholdings.
For single tax-payers, the process is convenient. Married individuals, who work, need to calculate their spouse’s tax withholdings also. For our example, we assume that your spouse receives a monthly paycheck and the amount withheld each pay period is $400. Add the two together to figure out your total household tax withholdings.
Calculating Tax Liability
Once you’ve determined your predicted withholdings, you need to figure out the amount you will owe in taxes for this year.
To help you walk through the process, IRS offers a tax withholding calculator as well as worksheets to let you complete a pretend tax return.
If you and your spouse are filing jointly, and your taxable income is approximately $81,300 for this tax year, you fall in the 22% tax bracket. Hence, you owe $9,600 in taxes. You do not have to deduct federal taxes mechanically from self-employment income. Freelancers or tax-payers that run a side business should incorporate that income into their tax equation.
Minus the Difference
When you get an estimate of the amount of money you owe, compare it with your total withholdings. Subtract your estimated tax liability from your annual tax withholdings. Continuing from example, your projected tax liability is $9,600. Therefore, you would have a potential $1,200 deficit.
When you get a positive balance, the value represents a refund. However, individuals who get a negative balance need to pay a penalty and interest to the IRS at tax time. However, the good news is that you can make fixes before tax time.
When you adjust your tax withholdings on time, you can guarantee peace of mind before and during tax time. Things can take an ugly turn, if you wait for a longer time.
Tax-payers have two options:
State additional withholdings: Tax-payers, who don’t want to disturb their allowances, should enter an additional amount they wouldn’t mind withholding from every paycheck. For that, you will have to divide your projected tax shortage by the number of pay periods you have left to reach your number.
Decrease personal allowances: The other way is to reduce the number of allowances you can claim on the W-4. With fewer allowances, you will end up with great withholdings.
When you complete W-4, you provide all the necessary information required by your employer to estimate how much income taxes, Medicare, and Social Security it needs to withhold from your paychecks to send to the IRS.
The purpose is to get accurate W-4 withholding allowances so your employer holds backs the exact amount you will owe in taxes by the end year end.
We understand that this is more complex than it sounds, but is is not impossible.
There is a worksheet attached to the W-4 form, to help you. You can also take help from calculator on the IRS website, which automatically makes all adjustments in case you might be eligible for any tax credits that have an impact on your tax liability. It caters to more than one income; in case you are filing a joint return as a married couple.
Your employer will make use of all the information you have entered on your W-4 to determine the percentage of your paycheck that has to go to income taxes.
Various factors affect the amount of income tax withheld, which also includes your filing status and the number of your dependents.
You can pay too much in Social Security tax, so it’s best to keep an eye on the withholding amount as it is something you will have to take care throughout the year if you are earnings are more than $132,900, referred to as the “wage base limit.” This limit increases every year after adjustment for inflation.
Remember to stay in touch with your employer and guarantee that the company realizes that you don’t have to contribute to Social Security by the next tax year if and when your earning hits this level. That is especially the case if you are working for more than one job and one or multiple employers withhold Social Security tax from your paycheck.
Some individuals are exempt from tax withholding. There is a box in Form W-4 that allows taxpayers to indicate so. Those who qualify simply have to complete boxes 1-4 and write ‘exempt’ in box 7.
People who have no tax liability or don’t expect any this year are likely to be exempt. This implies that you got a refund for all the money withheld from your pay last year. As the circumstances did not change, the situation is likely to be the same this year.