Although the headlines suggest that only top earners need to worry about a tax increase next year, the latest reports from the fiscal-cliff front tell a different story. The Washington Post and other media are reporting that President Barack Obama and House Speaker John Boehner have agreed to allow the payroll tax holiday to expire as scheduled on January 1.
If that happens, you won’t be able to take solace in the promises that only those making $200,000 (or $400,000 or $1 million) or more face a tax hike in 2013. In fact, every working American will be hit. Allowing the payroll tax (the levy that pays for Social Security) to rise from 4.2% to 6.2% will cost the average family an extra $1,000 in taxes next year; two-earner couples could owe an additional $4,000 or more.
[More from Kiplinger: CALCULATOR: What’s Your Share of the Nation’s Tax Burden?]
The payroll tax holiday began in 2011 as a replacement for the Making Work Pay tax credit, which was used in 2009 and 2010 to help stimulate the economy. Originally a one-year break, the holiday was extended at the last minute to cover 2012. Many observers expected another reprieve this year, to prevent a tax increase of more than $100 billion on American workers. But leaks from the fiscal-cliff talks say the holiday is in real jeopardy.
Use our calculator to see exactly how much your take-home pay will fall if the payroll tax holiday expires as scheduled. We can't protect you from the likely increase in the payroll tax. But we can show most taxpayers how to make sure that less tax, not more, is withheld from their 2013 paychecks.
How? By showing you how to limit or eliminate the overwithholding of income tax from your pay. Despite all the complaining about Washington, the undeniable fact is that middle-class Americans continue to allow the government to claim more than its share every payday. The proof: the 104 million tax refunds the IRS issued this past spring. The average check: nearly $3,000! That’s three times the threatened average increase in payroll taxes.
[More from Kiplinger: Kiplinger’s Easy-to Use Tax Withholding Calculator]
Do the math: By eliminating overwithholding of income tax, the average taxpayer who normally gets a refund can both defeat the paycheck-shrinking impact of higher payroll taxes and add a couple thousand dollars to 2013 take-home pay. (Yes, you’ll be giving up a fat refund in 2014, but wouldn’t you rather get your money when you earn it?)
The easy fix. It's simple to fix overwithholding. All you have to do is file a revised Form W-4 (PDF) with your employer. The information on that little form determines how much federal income tax is withheld from your checks. The more "allowances" you claim on the W-4, the less income tax will be withheld.
If you file a new Form W-4 claiming extra allowances before the end of the year, reduced income tax withholding will go into effect at the same time that the payroll tax holiday ends.
Ah, but how do you know how many allowances to claim? Worksheets that come with the W-4 will help, and you can get detailed instructions in IRS Publication 919, How Do I Adjust My Tax Withholding? (PDF). Or you can struggle through the IRS's online withholding calculator.
[More from Kiplinger: QUIZ: Is It Deductible?]
The Kiplinger Way
But we've got a better idea. If your 2012 and 2013 financial situation is likely to be similar to 2011's, take advantage of Kiplinger's Easy-to-Use Tax Withholding Calculator. Answer three simple questions (you'll find the answers on your 2011 tax forms), and we'll estimate how many additional allowances you deserve. We'll even show you how much your take-home pay will rise starting next payday if you claim the allowances on a new W-4.
Our quick-and-easy method is a helpful guide, not gospel. And it's based on the assumption that your financial life hasn't changed dramatically. If you have a new baby, get a new job or have an adult child who qualified as a dependent in 2011 but won’t in 2012 or 2013, for example, the calculator won't reflect how such events will affect your tax bill . . . and your tax withholding.
But for most Americans, our calculator will paint a reliable picture that should accomplish two important goals:
1) Get you motivated to grab a W-4 to pinpoint how many extra allowances you should claim; and
2) Get you more of your money as you earn it, as well as protect yourself from falling take-home pay due to the demise of the payroll tax holiday. Most people fill out a W-4 when they first take a job and never think about it again. But you can change the number of allowances at any time. You probably should if you received a tax refund of $500 or more -- or if you owed more than 10% of your total tax bill when you filed your 2011 return.
- payroll tax