Filing your taxes can be a daunting task. This is especially true when you are not confident that you had enough taxes withheld from your paycheck throughout the year. If you have had too little taxes withheld, you could end up owing a significant amount of money come tax time. On the other hand, if you had too much withheld, you effectively gave the government an interest-free loan.
How to determine how much to withhold in taxes?
When determining the correct tax withholding amount for your salary or wages, your objective should be to have just enough taxes withheld to prevent you from owing taxes when your tax return is due. There are two methods to do this.
Method 1: Using form W-4 and Publication 505
Two factors determine the amount of income tax that your employer withholds from your paycheck: the amount you earn and the information you provide on the Form W-4. This form asks you for three pieces of information: the number of withholding allowances you wish to claim, your marital status, and any additional amount you want withheld from your paycheck. The more allowances you claim, the less taxes are taken from your paycheck. Publication 505 (Pub 505) is a great resource that further explains the W-4 worksheet and the resources for which you may qualify.
Unfortunately, there are circumstances when even an accurate completion of the Form W-4 worksheet will not guarantee adequate withholding. These circumstances include if you or your spouse have more than one job, have significant non-wage income (i.e., IRA distributions, investment income), owe other taxes, or experience a lifestyle change that affects your tax deductions or credits. In these instances, Pub 505 can help you compare the total tax that you will withhold for the year with the tax that you expect to owe on your return. It can also help you determine any additional amount you may need to withhold from each paycheck to avoid owing taxes when you file your income tax return. Alternatively, it may also help you identify if you are having too much tax withheld.
Method 2: Using the IRS Tax Withholding Estimator Tool
The IRS has created the Tax Withholding Estimator to determine your most accurate withholding amount. This online tool is the most accurate when you have both your and your spouse’s (if applicable) most recent pay stubs and an estimation of any additional income available. It is also helpful to have a copy of your most recent tax return handy as a resource for non-wage income, if you have any. Once you are ready to begin, the online form will walk you through the series of questions to determine the amount you should be withholding from your salary or wages. The results will include instructions on how to adjust your W-4 withholding with your employer.
The IRS Tax Withholding Estimator Tool can be accessed on the IRS website.
How often should I check that I am having the proper amount of taxes withheld?
To avoid surprises at tax time, it is beneficial to periodically check your withholding as certain life events can affect your tax withholding. For example, if you get married, divorced, have a child, or purchase a home, you may need to adjust your withholding. Similarly, if you (or your spouse if filing jointly) change jobs or receive a raise, you will also want to check your withholding to make sure you are still on track. If you check your withholding and find you are not having enough withheld, you can simply complete and submit a new Form W-4 to your employer (these forms can be submitted as often as necessary).
Conclusion
Completing a form W-4 and determining the correct amount of taxes to have withheld from your salary or wages can be a challenge. If you have a complicated situation or are unsure that you have filled out the forms properly, we recommend working with your Financial Advisor, CPA or Human Resources Department.
Author: Alexis “Lexi” Houlihan, CFP®
Updated: June 24, 2024
Written: April 21, 2023