What The Heck Is Tax Withholding?

If there’s one thing we can all unite under in this great big world, it’s that we hate taxes. With good reason too, as our tax code has rapidly grown to an insane 6,550 pages of legal mumbo-jumbo. It’s not just our tax code we have to worry about either. Various court rulings and other legal conditions have skyrocketed our tax swamp to an estimated 74,000+ pages.

Yikes.

Well, we think taxes suck too, and we want to help shine some light on this ugly mire of complicated cacophony.

With that said, here’s a test for you:

  • Do you know what a W-4 is?
  • How about tax withholdings?
  • Allowances?

Don’t worry, if you don’t know, you’re not alone. Infact, nearly half of all Americans don’t know what a W-4 is at all.

Let’s take a look at one of the most overlooked, but important, tax tools available to us – the W-4.

What’s a tax withholding allowance?

By default your employer withholds the maximum amount from your paycheck to ensure all of your taxes are paid throughout the year, no matter what your filing status is.

For most people this means too much money gets taken out of each paycheck and you get it back in the Spring after you file your taxes. Rather than give the government an interest-free loan for the year, you can claim withholding allowances to keep that money in your pocket.

When you get a new job you’ll fill out a W-4 form which lets your employer know how many withholding allowances you want to claim. If you claim the minimum – 0 – they will take out the maximum amount of money and you’ll likely see a hefty tax refund come spring.

On the other hand, if you claim too many allowances you may end up with a nasty bill from the IRS in April.

Withholding made simple

If you’re still having trouble understanding such a silly system, maybe this will help.

Let’s say you want to buy a new TV. Instead of paying $1,000 right now, you choose to pay it off over 12 months in equal payments. Why? Because $83 every month is a whole lot easier to handle than dropping a grand right now.

Essentially, withholdings are attempting to do the same thing – turning your taxes into a payment plan system. Seeing as the average American owes over $10,000 in federal taxes, it’s no surprise that we want to piecemeal it out.

Now let’s say the TV you bought only cost $700, but the company doesn’t know so you’re still being charged $83 a month. After 12 months you’ve overpaid $300, in that case the company sends you a refund check for that amount. In the end you’ve still only spent $700 but your monthly payments were higher than they needed to be.

Claiming withholding allowances is like telling the company to adjust that monthly payment to $59. By the end of the year you’ve paid $708 so you get refunded $8 instead of $300 but you got to keep an extra 24 bucks in your pocket each month.

What should my tax withholding be?

The safest way to figure out how many withholding allowances you should claim is to start off with 0 or 1 for the first year and then adjust from there. If you get a large refund you should be safe to increase your withholding by 1. If you end up paying during tax time then you’ll want to adjust your withholding back down.

Naturally, your filing status also plays a role in how much taxes get withheld from your paycheck. When you get married, don’t forget to update your status on your W-4 to make sure your employer withholds the right amount!

To summarize:

  • Claiming a lower withholding – 0 – will take the most from your paycheck, but you’ll see a large tax refund at the end of the year
  • The higher you claim – 1, 2, 3 or 4 – the less that will be withheld. Your paycheck will be bigger, and your tax refund will be smaller
  • Don’t go too high, or you’ll likely end up owing the IRS

Why should I bother changing my allowances?

Realistically, you don’t have to ever change your tax withholdings. Meaning, it inevitably comes down to how you prefer to handle your money.

Are you the type of person who prefers to have a larger paycheck right now? Then micromanaging your W-4 can provide a rather significant increase in your weekly / monthly pay. Just be careful you don’t go overboard.

On the other hand, if seeing a “bonus” at the end of the year makes you giddy, then by all means keep your tax withholdings low. Just remember that your paycheck will suffer as a result.

In either event, it’s important to keep in mind that you’re not gaining or losing money here. This is simply a matter of when you see your money.

Of course, this is all assuming that you’re getting a refund in the first place, which isn’t a guarantee. Depending on your unique financial situation, you could still owe back taxes to the IRS – even with a large withholding on your paycheck. This is why we recommend that you take things slow!

Still not sure what your tax withholding should be? The IRS has a handy calculator you can use to figure out what works best for you.

TL;DR

Hey, now that you understand your W-4, maybe you’ll hate taxes a little less?

OK, probably not, but at least now you’ll be happier knowing you can have a little more control of your money!


Find this article helpful? Subscribe to our newsletter to never miss out on awesome finance tips!

Puppy Tax Withholding

The only allowance Mika gives is more plays.

picture of mika with a ball

You May Also Like

Avatar

About the Author: Dakota

Leave a Reply

Your email address will not be published. Required fields are marked *