If you are like most Americans, you pay most of your annual taxes through payroll withholding. A percentage of your income is deducted from your pay each pay period and sent to the Internal Revenue Service where it is credited toward your annual tax bill. Payroll withholding is something you will want to get right as paying in too much means you let Uncle Sam have the free use of your money for the year. Too little, and you will end up owing at tax time in April.
Not an Instant Raise
Many people look at changing their W-2 forms and increasing the number of deductions they take as an easy way to get a "raise". But, beware, decreasing the amount of federal taxes withheld from your pay check may only result in you having to cough up the money on April 15 next year. While it is sometimes very tempting to decrease the amount withheld from your check, most good financial planners advise against it. Withholding the "proper" amount from your check is just good budgeting and you will not spend money you really do not have. The proper amount is the amount that leaves you not owing the government nor getting anything except a modest refund.
Change Witholding When You Get a Large Refund
If you regularly get a big tax refund, you may want to decrease the number of personal allowances you claim. Use the IRS tax calculator to determine how much money you should have withheld from each pay check. But, then do not automatically spend the money. Instead, put it in a savings account or contribute to your retirement account. The key here is for you to earn the interest, not the IRS.
Change Withholding When You Owe Uncle Sam
You should also increase your withholding if you owe the government anything but a small amount of money. If you end the year with a big federal tax bill, that means you have essentially been living off of borrowed money. Tell yourself to get back to budgeting basics and adjust your withholding so that you do not owe a large tax bill.
How to Adjust Your Withholding
To make any change in your withholding, you must file a new W-4 form with your employer. This changes the amount taken out of your check. You should also change your withholding any time you experience a major change in your life such as marriage or the birth of a child. These circumstances affect the amount of taxes you will owe.
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