Personal Finance 

How to Adjust Your Tax Withholding

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Tax entry in DictionaryEvery year, millions of American taxpayers get a tax rebate in the Spring. For some, it’s a planning tool – you can’t spend money if you don’t have it in your bank account. For others, it’s just something that has always happened. It isn’t a benefit, it isn’t a drawback, you’ve just always gotten a rebate in the Spring and it’s been a night surprise.

What if it didn’t have to be that way? What if you could do something to avoid giving the government a tax free loan each year for no reason? Fortunately there is and it involves adjusting your tax withholding on your paycheck.

This post is part of the Bargaineering Annual Financial Review week series where we take a closer look at the four major facets of personal finance and see if we can do better. This post is part of day four – beating back the tax man.

Income tax is paid “as you go.” Every paycheck you receive will have a little, or a lot depending on your perspective, taken away and paid to the government in the form of federal income taxes. As you earn the income, it is taxed immediately. Your employer determines how much tax to withhold based on your Form W-4.

This works well when you’re single and claim the standard deduction. If you’re married, have two incomes, claim itemized deductions, or are in any one of a million non-standard deduction scenarios, the W-4 works but it doesn’t work that well. That’s why so many people get tax rebates, their employers are withholding too much tax.

How to Adjust Tax Withholding

The easiest way is to use the IRS’s Withholding Calculator to help you decide what to claim. With the various credits introduced in the recent stimulus bill, the American Recovery and Reinvestment Act of 2009, I wouldn’t trust any other calculator to give me accurate information. The calculator will tell you how to fill your W-4 once you enter your information.

Safe Harbor Protection Amounts

For the more advanced withholding adjusters, you can adjust it so that you owe a little tax at the end of the year. The government doesn’t like it when you underpay your taxes because then they are giving you an interest free loan. Fortunately, as long as the taxes you do pay exceed last year’s tax liability (110% if your AGI os ver $150,000) or is within 90% of your actual tax liability, you will not face penalties. You will want to check with your state’s rules as well because they may differ from federal Safe Harbor guidelines.

This exact topic was the subject of a recent Angel’s Advocate and Devil’s Advocate post. In the Angel’s Advocate post advocating adjusting your W-4 withholding, I explain a few reasons why doing this is a good idea. In an older but still poignant Devil’s Advocate post, I argue why adjusting your withholding might cause more problems than its worth.

Whatever direction you decide to go on this, at least you’ll know what to do. Do you adjust your withholding?

(Photo: alancleaver)

{ 15 comments, please add your thoughts now! }

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15 Responses to “How to Adjust Your Tax Withholding”

  1. NateUVM says:

    For years, like most other people, I just liked getting what amounted to a bonus check in the mail (or via ACH direct deposit). It was like an automatic savings plan, but without any earnings.

    Finally decided that this was a little silly, and adjusted my withholding. Now I take the difference in my paycheck and put it into the Roth 401(k) that my company is now offering.

    While I probably should have done so, regardless, it was probably this new offering that gave me the initiative to make this change. The capacity to add to my “Roth” funds was too powerful to ignore (I already contribute the max to my own Roth IRA).

  2. Chris says:

    I have adjusted my family’s withholding to reduce the amount of my tax return and increase our cash flow. I would love to be able take an interest free loan from them for once.

  3. jsbrendog says:

    i went through all of this this past year after doing my taxes and being told that with my current withholdings i would be short and owe a ltitle bit this year, so i had to ajdust it. it was quite ocnfusing. simple once understood but confusing nonetheless

  4. If we make the mistake of under witholding too much there is a big penalty.

    John DeFlumeri Jr

    • saladdin says:

      True. But if you use the IRS calculator you can get it down to a few dollars. I don’t think anyone here is saying just pick a number.


  5. pcallaghan says:

    I’ve gotta go through all my tax withholdings. With the purchase of a house there needs to be a change. Also am in the process of convincing my girlfriend to stop giving the government that free loan. Big checks are nice but come on, it could be a larger amount if you had that money up front.

  6. zapeta says:

    My withholding usually ends up being pretty close to what I owe without a lot of changes. I prefer to get a (small) refund…I’d rather get a little back than have to come up with the money and pay them.

  7. I gotta tell ya, I’m one of the dummies who LOVES a refund!

    Let’s say you did lend the government $5,000, you’re giving up what, $55 bucks in interest for the year based on a 1% savings interest rate?

    Heck, take tht money away from me and keep it! I know I’d spend that tax refund instead of save, if it was divided into $410/month for 12 months!

    • saladdin says:

      This is where Ramsey can come in. It’s not the “giving a free loan” thing as much as it is a behavioral thing. If you do not have the discipline to save/invest the money throughout the year then get a refund. But you have to use the refund for good, not evil.

      But limit your refund. You don’t want to get a 5K refund. That’s just poor financial planning. If you want to get 1500 back sure but 5k is extreme. That’s a lot of money throughout the year that can be used to pay off debt or spend on beer and ho’s.


  8. Shock says:

    I review my withholdings every year and adjust when necessary. My goal is to get close to the break even point. It seems like every year my situation changes and I use the IRS withholdings calculator, but I still get a refund. The biggest refund comes from my state (Virginia) taxes, which seems to have a cap on the number of withholdings.

  9. Ryan says:

    So I need my end of the year paycheck to fill out the info. on this calculator?

  10. Justin Kubicek says:

    Is there anything we can do about our renters rebate? It seems stupid. I’m going to get 19% of what I paid in last year. I pay $725 now, and with 19% taken off it’d feel like I would be paying $588 per month.

  11. Matt says:

    So do I go up to my boss and ask for a new W-4 or can I do this online? Anyone know? I have no state taxes deducted from my paycheck and like $20 something deducted for federal taxes every week so it will be around $1000 that I get back next year, but I would like the extra money on every paycheck more.

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