As 2017 rambles to a close I know that many people are looking forward to the most wonderful time of the year. No, I am not talking about or or . Those holidays ain’t got nothing on
People walk into H&R Block with their W-2 and come out like
A February 2015 IRS news release reported that with two months to go until the tax filing deadline, the IRS had already processed nearly 50 million returns. Almost 83% of those returns resulted in a refund, the average of which was $3,120. Now I don’t know about you, but I think that’s some good money. I could do some things with $3,120.
Although we are about three months away from tax refund season the end of the year is actually the best time to not only prepare for the current year’s return but to also get set up for the next year’s. The first step is to figure out how to not get that tax refund in the first place.
Hear me out. I do want that $3,120 but I’d rather not have to wait to get it. What most of us forget is that income tax refunds are not special government money for which one qualifies. It’s your salary that was withheld from your paycheck throughout the year with which you overpaid your tax bill. The IRS holds on to all of that extra money for an entire year (or more if you’re like me and don’t do your taxes until June) then gives it back without one cent of interest. Would you let some random person just hold that type of money for a year and then give it back to you without interest? If you said yes
Banks don’t let you just hold something for a year so you should not allow the IRS to do so. That average tax return is $260 each month that you could have had. All of those times you said you could not afford to pay down debt, contribute to your 401K, or when there was just too much month left at the end of your money I’m sure that $260 would have come in really handy.
I know that for some people this is old news. I discovered this gem over a decade ago during a sermon at church. Since then my goal has always been to be +/-$100, meaning that I either owe or get refunded about $100 each year. However, figuring out how to make this happen has been a lot more difficult than I thought it would be. Last year I received an $800 refund. The year before I wrote the government an $8000 check. I think that this is the year that I have finally figured it out. Here is how.
The way to control how much tax is withheld from your paychecks is with the W-4 withholding form. When I started my first post collegiate job my father gave me some of the worst advice ever. He told me to claim 0 exemptions on my W-4. Why? Being the overly cautious person that he is he did not want me to owe income tax when I filed. Not only did I not owe any tax that year, I received a $5,000 return (which I used to pay off debt and buy a bed for the apartment I’d been living in for the last 7 months). Oh, I was also persistently broke throughout the year because after paying rent and bills there was never much left over. I could have stopped sleeping on the floor months earlier if I was getting $416.66 each month in my take home pay.
Filling Out The W-4
Most people only look at a W-4 when starting a new job. No one is fearful of not claiming enough allowances. However, they are scared shitless to claim too many and wind up owing. The worksheet at the top tries to help us figure out how many allowances we should have.By line B I’m already confused trying to figure out how many allowances I should claim.
A major key to filling out the W-4 is understanding the 1040 tax return form and the dollar value of exemptions.
First, understand that exemptions are a monetary exemption that reduces taxable income. Each exemption you can legally claim reduces your income by $4050. These are designated at the beginning of IRS Form 1040 (i.e. your tax return form)
When I file I get to check box 6a. I do not have a spouse (because Beyonce stole Jay-Z from me) and my friends are selfish and will not loan me any of their extra
exemptions children to claim. Each year I am my one and only exemption. Where the confusion comes in for many people are on lines A and B of the W-4 worksheet.
Both lines A and B apply to me, but I only count the “1” for line A. Why? Because this is me telling the HR department ahead of time how many exemptions I will claim on the 1040 and then they know how much tax to withhold for the IRS based on my salary-($4050 x the number of exemptions). If the exemptions here are too high then not enough tax will be withheld and I will owe.
If you only have one source of income, don’t own securities or investments, have no adjustments to income (i.e. student loan interest, IRA deduction, tuition and fees, etc.), and don’t itemize your deductions then your return is super basic and claiming 1 exemption on the W-4 and the 1040 should allow you to keep more of your salary in your paycheck and break even when you file.
How To Use The IRS Withholding Calculator
However, if you’re doing any kind of adulting chances are that your taxes are more complex. Last year I discovered the handy dandy IRS Withholding Calculator. With the input of some simple data it spits out how many allowances to claim on your W-4*. I like to go through it during this time of year to make sure I’m tracking to break even. I’ll show you how.
- I gather my previous year’s return and my most recent pay stub and go to IRS Withholding Calculator site.
- I input my filing status for the year and verify no one can claim me as a dependent (although I am up for adoption if anyone wants to support me in the lifestyle to which I’ve become accustomed).
- I put in the number of jobs I held for the year. I don’t count my side hustles since the income I earn with them isn’t taxable (another post for another day). I check the tax-deferred retirement box to account for my 401K and the pre-tax cafeteria plan box to cover other pre-tax deductions (HSA, FSA, transportation).
- I’m going to break the next section into three parts. Here is where I use my paystub and last year’s tax return.
- I estimate my full year salary. I include bonus and stock award payments in the first box. I do this for simplicity and because I do not receive separate checks for these payments. By this point in the year I’ve already received my bonuses and I can easily estimate the value of any stock that vested this year. The rest I fill out based on my full-year contribution commitments to my 401K, HSA, FSA, and wage works. I round my numbers to the nearest dollar
- The nonwage income section is a summary of lines 7 thru 22 on the 1040 form. I use the information from last year’s return as a guideline for filling in this part. Any other taxable earned income is defined as tips or net self-employment income (professional fees and other compensation paid to you minus expenses). Last year I had state income tax refund income (because I itemize and deduct state and local taxes from my federal return I have to report this) so I entered my state of IL refund in the first box. I will also have capital gains and dividend income from my stock and mutual fund investments. I just used my numbers from last year’s 1040 as a guideline and entered it into the third box
- The adjustments section corresponds to the Adjusted Gross Income section of form 1040 (lines 23-37) Here is where you’d summarize all of your adjustments like the IRA deduction, tuition and fees, moving expenses, student loan interest, etc. It’s good to look at your most recent return, student loan statements, and business receipts (if you qualify) to get a good estimate. Since I do not have or qualify for any of these adjustments I left this section of the calculator blank and then continued to the next page.
- The deductions page is a summary of the Schedule A tax form. If you itemize your deductions you should be very familiar with this one. I deduct mortgage interest, property taxes, state income tax, and charitable giving. To get these numbers I use my mortgage statements and multiply the most recent interest payment by 12. Because this amount shrinks a little bit each month this number isn’t exact, but since it’s towards the end of the year it gives a pretty good average and I don’t overestimate. I check my paystub to see how much state tax I’ve paid thus far and then multiply the amount withheld from that check by the number of pay periods left in the year. I add that to what I’ve already paid to get my estimate. The majority of my giving is to my church so I just check my payment history there to get a ballpark figure for the year. If you are a regular giver and always give the same amount or percentage then you’ll know this number spot on. If you claim any of the other deductions just check your receipts or last year’s Schedule A to get an estimate. If you don’t itemize the system will just use the standard deduction for your filing status.
- All of this information goes into the degunkulator and spits out your expected tax obligation for the year, how much you will pay at your current withholding, if you will have an under or overpayment, and how to adjust your W-4 allowances to either have more money withheld from your checks (if you’re projected to underpay) or have less money withheld (if you’re projected to overpay). With my current allowances I am looking at a $961 refund. To get my money now rather than in June when I typically file I would need to increase my allowances to 26 on my W-4. If I did that I would get an expected refund of $175 which would put me much closer to my goal of being +/-$100 of my tax bill.
If you go through the calculator and it gives you the good news that you’re more than meeting your tax obligation then simply change your W-4 form. You can do it any time during the year as many times as you like. It usually takes one to two pay periods to take affect. I highly recommend making this move and giving yourself a nice raise through the end of the year. Just PLEASE ON ALL THAT IS HOLY DO NOT FORGET TO CHANGE IT BEFORE JANUARY 1! I recommend setting an alarm on your phone for December 15 to change it back to 1 or however many dependents you will be claiming. Then after your first paycheck in January run your numbers again to get your correct withholding number for the year.
Sometimes Pen and Paper Is Best
There is a caveat to this tool. It works best for people who have consistent income throughout the year (i.e. no super large bonus or stock awards that hit toward the middle or end of the year). When I do this at the beginning of January using full year numbers it always tells me I am underpaying because the taxes on my base pay are obviously much less than the taxes I pay at bonus time. So in order to get an accurate withholding number from day one I break out the trusty pen and use the W-4 Deductions and Adjustments worksheetThis worksheet lets you figure out how many allowances to take based on your deductions. I would enter $31,779 in line one which is the total of the estimated itemized deductions I put in the calculator. On line two I’d enter $6,350 since I file as single. Subtracting line 2 from 1, I get $25,429. I don’t anticipate having any adjustments to income or standard deductions so I enter 0 on line 4. On line six, I estimate that I will have $467 in non wage income from state tax return, dividends, and capital gains (same numbers in the calculator above). I subtract that from $25429 to get $24,962. I then divide $24,962 by $4050 to get 6.163456790123457. I drop the decimal and enter 6 on line 8. Remember the Personal Allowances worksheet I mentioned about 1700 words ago? I take the number from line H, which for me is 1 and put it on line 9 of this worksheet. I add lines 8 and 9 to get 7 (6+1 in case you got lost) total personal allowances. I would then enter 7 on line 5 of the W-4, submit it to HR, then breakeven with Uncle Sam when I file the next year.
If you have multiple jobs or are in a dual income household the bottom half of the worksheet is for you.I can’t walk through it with my numbers because this ain’t my life. However it appears pretty straight forward.
Whether you are or at tax time these tools can help. If you have a healthy fear of owing the IRS (it only took once to scar me for life) then it’s ok to take baby steps. If the calculator is telling you that you can take 5 allowances do 4 and see what happens when you file. Another option is to take the 5 but withhold an additional amount just in case. I’d recommend not adding any more than $25 per month as anything above that kind of defeats the purpose of putting more money in your pocket throughout the year. The great thing about the W-4 is that you can change it as often as you want throughout the year at any time. Yes, it’s basically like doing your income taxes yourself, but I personally enjoy going through this exercise and think that everyone should have at least this level of knowledge about their tax situation. If you’re a little nervous that you didn’t get it right run your numbers through the calculator every 4 months and adjust accordingly. Be sure to make changes in your W-4 if you have major life changes such as marriage, divorce, more dependents, extra jobs, or a major increase in deductions (i.e. you buy a house or start giving a whole lot more to charity).
Ultimately, you want your money up front so that you can reduce the amount of interest you pay on debt (the sooner you pay it the less principal is accruing interest) or increase the amount of interest you earn (the sooner you invest the greater the return) in investments or to just give yourself some more discretionary funds. If you typically used your tax refund to pay for vacations or were going to use it to purchase a new vehicle you are still better off getting more money each month and direct depositing it into a free Capital One 360, Ally, or even a One United Unity E-Gold (bank Black ) savings account where you’d annually earn .75%, 1.2%, or .4%, respectively. If you’re scared you’ll spend it just decline the ATM card and don’t connect it to any of your other bank accounts until you’re ready to purchase that vehicle or those flights. Also, please know that I am not an accountant or tax professional. If this is all new to you then I strongly suggest sitting down with someone licensed to do this and work through your numbers. Tell them your over/under goal and check your estimates against their recommendation.
I will tell you right now that if you’re used to “getting money,” you will feel some kind of way when your cousin ReeRee gets her $5,000 refund. Just remember that ReeRee likely has to pay off the Christmas layaway and get current on her light bill with that money while you were able to pay less in taxes and make a 10% return because you got your money when you earned it and were able to invest in a traditional IRA.
*This Withholding Calculator works for most taxpayers. However, if you owe self-employment tax, alternative minimum tax, or certain Other Taxes; you should use the instructions in Publication 505, Tax Withholding and Estimated Tax.
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