The IRS has a new calculator to solve your W-4 confusion
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The first day of a new job usually involves filling out a bunch of forms. One of them is your W-4. It's not a catchy or descriptive name. If it were up to me, it would be called the "How much of my paycheck should go to taxes" form.
That's because the form tells your employer how much of your paycheck to withhold for federal income taxes. Hence the name.
If you're like me, you don't give your W-4 too much thought when you're filling it out and even less after, even if your tax situation may have changed. But it's a good idea to keep it updated, because it affects both your take-home pay and the size of your tax refund.
Not sure how to fill one out? The IRS recently released a withholding calculator to help identify how much of each paycheck you should set aside for taxes.
Using the calculator is easier if you have a few recent pay stubs and your last income tax return. The first thing the calculator asks is your filing status: single, married filing jointly, married filing separately, head of household or qualifying widow(er). You'll also need to estimate your 2018 income before taxes and add up how much federal income tax has been withheld from your pay so far this year.
The calculator does its magic, then tells you how much income tax you can expect to pay for the year, your expected return based on your current withholding and how to change your withholding to reduce the size of your return.
You might think of your tax return as a bonus you get from the government every spring. It's not.
Here's how it works: Each year, you owe a certain amount of income taxes based on your income and deductions. (This may have changed for you this year thanks to a new tax law.)
"Withholding is a way of prepaying that bill," said Allan Katz, a certified financial planner president of Comprehensive Wealth Management on Staten Island, N.Y. "Each employee can choose how much is withheld by choosing how many dependents they have."
If you put a higher number on your W-4, less money comes out of each paycheck, and less money goes toward paying your tax bill.
"This will make each paycheck seem larger, but at the end of the year, your refund will be smaller, or worse, instead of a refund, you will owe money," Katz said. "This may also cause penalties or interest."
Conversely, if you put a lower number of allowances on your W-4, your paycheck will be smaller and you'll set aside more money for your tax bill. If you do that, you're more likely to get a bigger refund. You get a refund at tax time when the money taken out of your paycheck adds up to more money than you owe in taxes, and you owe money when you don't withhold enough from your checks to pay your tax bill.
"Some people feel that you shouldn't withhold too much because you are in essence giving the government an interest-free loan," Katz said.
That's one way of looking at it. The refund you get is your money. It's the change left over from paying your tax bill. If you're withholding too much, you're basically letting the government hang on to it until tax time. You could stick it in a savings account instead and earn some interest or find some other use for it.
"Others like to use this as a forced savings and then use the refund for different purposes," Katz said.
It might not be the most productive use of your money, but if you think you would waste the extra cash instead of saving it, maybe it's better for the government to hang on to the money. The IRS calculator doesn't seem to advocate for this. It always recommends closely matching your withholding to your actual tax bill so your refund is as small as possible.
That's why Katz recommends speaking with a tax preparer or financial adviser to see what the best option is for you. Make sure it's someone you trust, though. Katz mentioned that some accountants like to withhold as much as people so it looks like they scored their clients a big refund. Just remember: A big refund isn't always a good thing.
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