A common question we encounter is: How much in taxes should I have withheld from my paycheck?
This is a frequent thought once the prior year’s tax returns have been filed and individuals are looking ahead to the current year. Reviewing your withholding periodically is important because if you do not estimate your income tax withholding properly, it may result in an underpayment of taxes. If you were not planning on owing tax, it may be difficult or at least inconvenient to gather the funds for payment quickly. You may also be subject to an underpayment penalty from the IRS or state taxing authority in addition to the payment of the tax due.
The general guidelines are that you must have paid in through a combination of withholdings and/or estimated tax payments at least 90% of your current year tax or 110% of your prior year tax to not be subject to an underpayment penalty on your Federal tax return come tax time. Many states follow similar guidelines, but some states do have their own specific rules regarding tax payments and underpayment penalties.
Your tax advisors are available to review your current withholdings and make recommendations on any changes that may be necessary given your personal tax situation. However, we would also like to provide information on how withholdings are calculated and what goes into determining your tax withholdings.
FORM W-4: HELPS YOU DETERMINE THE PROPER WITHHOLDING AMOUNT
Two factors determine the amount of income tax that your employer withholds from your regular pay: the amount you earn and the information you provide on Form W-4. This form asks you for three pieces of information:
- The number of withholding allowances you want to claim: You can claim up to the maximum number you’re entitled to, claim less than you’re entitled to, or claim zero.
- Whether you want taxes to be withheld at the single, married, or married with tax withheld at single rate: The married status, which is associated with a lower withholding rate, should generally be selected only by those taxpayers who are married and file a joint return. Those who are married and file separately should select married with tax with- held at single rate.
- The additional amount (if any) you want withheld from your paycheck: This is optional; you can specify any additional amount of money you want withheld.
COMPLETE THE WORKSHEETS TO CLAIM THE CORRECT NUMBER OF ALLOWANCES
An important part of completing the Form W-4 is the number of you are entitled to claim. As stated earlier, you can claim up to the maximum number of allowances you are entitled to based on your individual tax situation or you can claim fewer (including zero) if you want more in withholdings from your paycheck. The more allowances you claim, the less taxes are taken from your paycheck. Therefore, the net paycheck you receive each payperiod would be higher. You can maximize the amount withheld from your paycheck by claiming zero allowances. This will increase your withholdings and reduce the amount of money you take home in your paycheck. The following factors determine your number of allowances:
- The number of jobs that you work
- The deductions, adjustments to income, and credits that you expect to take during the year
- Your filing status
- Whether your spouse works
To calculate the correct number of allowances for your personal tax situation, you will need to complete the Form W-4 worksheets. Your tax advisor can help explain the worksheets and provide an analysis of the impact on your withholdings if you claim fewer allowances than the maximum you are entitled to claim.
CHECK YOUR WITHHOLDING
There can be additional considerations besides your wage income when reviewing your withholdings. In the following cases, accurate completion of the Form W-4 worksheets alone won’t guarantee that you’ll have the correct amount of tax withheld:
- When you’re married and both spouses work, or if either of you start or stop working
- When you or your spouse are working more than one job
- When you have significant non-wage income, such as interest, dividends, alimony, unemployment compensation, or self-employment income, or the amount of your nonwage income changes
- When you’ll owe other taxes on your return, such as self-employment tax or household employment tax
- When you have a lifestyle change (e.g., marriage, divorce, birth or adoption of a child, new home, retirement) that affects the tax deductions or credits you may claim
- When there are tax law changes that affect the amount of tax you’ll owe
While this discussion focused largely on Federal withholding and Form W-4, most states have a similar withholding form to complete to adjust your with-holdings. If you find that you need to make changes to your withholding, you can do so at any time by submitting a new Form W-4 (or equivalent state form) to your employer. If you would like to have a review of your tax withholdings, please contact your tax advisor. We can discuss your individual situation and make a recommendation regarding your tax withholdings going forward.
Amy Cudia | CPA | Tax Advisor firstname.lastname@example.org