Most taxpayers get refunds every year. And a lot of them do so because they have too much withheld from their paychecks.
But such overwithholding is bad. You're giving the federal government an interest-free loan of your money for the year. The IRS would never reciprocate by giving you one, and in fact imposes stiff penalties and fees to those who don't file or pay on time.
Underwithholding, which means you'll owe the IRS when you file your annual 1040, isn't recommended either. If you owe a lot when you file your return, you could even face underpayment penalties.
|More From Bankrate.com:|
• Choosing Your Tax Return Form
• Who Has to File a Tax Return?
• 10 Common Tax-Filing Mistakes to Avoid
Filling out the W-4
The Form W-4 is short, but not all that simple to folks with complex lives. This step-by-step explanation will help.
What to do if your tax bill is off kilter1. Fine-Tuning Your W-4
2. Deductions and Adjustments Worksheet
3. Two-Earners/Multiple Jobs Worksheet
4. Online Assistance
It's easy to do.
First, look at your prior year's tax bill. If the amount you had withheld was very close and you haven't had any major lifestyle changes, then leave your payroll withholding alone.
But if you owed a lot or got a big refund, then it's time to adjust your withholding.
You also might need to fine-tune your workplace taxes if things in your life have changed substantially. Did you get married, have a child, buy a house or receive income that's not subject to withholding, such as interest income or capital gains profit? These will affect your eventual tax bill, so you need to account for them in your withholding amount.Fine-Tuning Your W-4
You can make the changes any time during the year by simply going to your payroll office and filing a new W-4. This is the form your employer uses to calculate how much in taxes will be taken from each paycheck.
The more allowances you claim on your W-4, the less income tax will be withheld. The fewer claimed, the larger the withholding amount.
To help you determine the correct number of allowances, you'll find an eight-line Personal Allowances Worksheet. It's actually the first part of the Form W-4. If you have only one job, are single or married to a nonworking spouse, and don't itemize, the W-4 process is fairly simple.
You get one allowance for yourself, your spouse and one each for your children or other dependents.
Your filing status also will affect your allowance amount. You get an extra one if you file as head of household; another if you claim child or dependent-care expenses of more than $1,500 a year.
Finally, any child tax credits you claim will be taken into account.
The total of all these considerations is the number of allowances listed on your W-4. This number probably will not be the same as the exemptions you claim when you file your return in April. With the W-4, you're figuring the credits and expenses upfront rather than subtracting them at the end, as you do on your 1040.Deductions and Adjustments Worksheet
If your life is a bit more complicated, so are your W-4 calculations.
If you itemize, have a second job or a working spouse, you'll need to complete the two worksheets on the back (Page 2) of the form.
The first is the Deductions and Adjustments Worksheet. This is necessary if you itemize expenses on Schedule A. With this worksheet, you'll take those deductions into account now so that your withholding will more accurately reflect them.
This worksheet also considers other income you might have, but which isn't subject to withholding, such as dividends and interest. Other adjustments to your income, popularly called above-the-line deductions, also are part of this worksheet's calculations. These include such things as alimony paid, deductible IRA contributions and student loan interest.
Your total Deductions and Adjustments allowances then are added to the number you figured on your Personal Allowances Worksheet on Page 1.Two-Earners/Multiple Jobs Worksheet
If you have two jobs or your spouse works, further withholding adjustments might be necessary. The second worksheet on Page 2 of the W-4 form will help you come up with the appropriate amount.
Working couples should do the calculations together. The IRS says withholding will be most accurate for two-paycheck families when all eligible allowances are claimed on the W-4 of the spouse with the larger income; the other spouse should then claim zero allowances.
This worksheet also gives you the opportunity to figure actual additional dollar amounts you would like withheld from your paychecks. This sometimes is necessary so that you won't end up with a big tax bill.Online Assistance
While the W-4 form is one of the shortest IRS documents, that simplicity is overshadowed by the attached worksheets. The calculations often deter individuals from making the necessary payroll withholding adjustments.
But there is another way.
To help with the calculations, the IRS has created an online W-4 worksheet. The interactive calculator will walk you through the various worksheet scenarios and tell you just what number to enter on your W-4.