Setting your W-4 Correctly

Setting your W-4 CorrectlyOne money mistake you can make is not setting your W-4 correctly. You do not want too much withheld from your paycheck so that you get a large refund when you file your taxes, and you do not want to have too little withheld so you have to scramble to come up with thousands of dollars when you file your taxes. Throughout the year, you want to pay in just the right amount. Most employees should be able to have enough withheld from their paychecks so that they are within $500 of their tax bill. Your employer withholds federal income tax from your paychecks based on the information you provided them when you filled out your W-4.

Available Tools

You can use available tools to determine how many allowances you should have set on your W-4. CalcXML has a couple of tools that you can use for calculating your tax and your allowances. For federal tax liability, you can use their federal income tax calculator. For calculating your W-4 allowances, you can use their payroll withholdings calculator. Calculators can make it easy but understanding how to do these calculations yourself is beneficial. For most tax situations, you do not need to be a CPA or a math nerd in order to do this.

Determine Your Tax Liability

Start by knowing how much federal income tax you will need to pay for the year. In the previous post, I explained how to do this. Now that you know how much tax you will owe for the year, you can determine if you are having your employer withhold enough throughout the year.

Check Your Latest Paystub

After you know about how much tax liability you will have, you check your latest pay stub, and that will show you two things. First, it will show you how much federal income tax you have already paid in for the year. And second, it will show you how much is being withheld from your paycheck each pay period. If you have already paid in enough tax for the year, you can increase your allowances on your W-4 so you have very little federal tax withheld for the rest of the year.

If you have not paid in enough federal tax yet, you need to determine how many pay periods are left in the year for you. Take the number of pay periods left and multiply this by the amount you have withheld each pay period. Add this number to the amount you already have had withheld. This is going to be the total amount of tax that you will have withheld from your paychecks throughout the whole year if you do not change anything on your W-4. Compare this number to the total tax liability that you will have.

If you are within $500, you do not need to do anything else. Call it good. If you are going to pay in a lot of additional tax or are going to get a large refund when you file your taxes, you need to consider changing your W-4.

Check Your W-4

Most people who work for larger employers can check their W-4 online at work. If you do not know how to do this, or if you don’t have that option, check with your HR department and ask them how you can look at your W-4 and possibly change it.

Your W-4 has three pieces of information that you need to know. The first is your tax filing status. Mark “Single” or “Married” based on how you will file your taxes. The second piece of information is the number of allowances that you have set, and the third piece is any extra withholding that you have set. These three values determined how much federal income tax is withheld from your paycheck each pay period.

Changing Your W-4

If you have too much or too little withheld from your paychecks, then you need to change your W-4. If you are having additional money withheld from each paycheck, then you can increase or decrease that number in order to get closer to having the right amount withheld each pay period. The “Additional amount withheld from each paycheck” field should be blank or $0.00 for most people. Use this field only if you have not been having anything withheld and need to catch up.

To determine how much an allowance is worth, you can increase or decrease your allowances by 1 and wait for it to reflect on your paycheck in one or two pay periods. This depends on your company and how fast they process the information.

Once you know how much an allowance is worth for you, increase or decrease them based on your total tax liability for the year, how much you have already paid in for the year, and how many pay periods you have left in the year.

Stay on Track

Check your paystub often to make sure you are on track. If you pay in too little and owe more than $1,000 when you file your taxes, the IRS will hit you with a penalty. If you pay in too much, then you have money sitting at the IRS. When you are not on track, change your W-4 and wait a couple of paychecks, and then check everything again to see if you are on track. If your employer allows it, keep adjusting your W-4 until you have the correct number of allowances.

When Income and Tax Situations Change

There are a few times when you need to re-evaluate your W-4 information. If you become single or married, have a change to your qualified dependents, or your income changes during the year, you need to reevaluate your W-4 information. If you get a bonus during the year, you need to reevaluate your W-4 information. Most bonuses are taxed at a higher tax bracket then your regular paycheck is taxed. If your allowances were set correctly and you get a bonus, you will most likely be able to increase your allowances for the remainder of the year. There’s no need to have that money sitting at the IRS, especially if you are paying interest on any debt you have.

Withholding a proper amount from each paycheck is part of being intentional with your money. Changing your withholdings is not overly complicated. Having the right amount of tax withheld from your paycheck throughout the year can help you avoid a common money mistake. Don’t give the IRS free money. Use that money throughout the year to pay off your debt, save for your emergency fund, or invest and build wealth.


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