Basically taxes come down to 4 numbers….
1) Total income from all sources
2) What deductions and credits do you quality for?
3) These combine to create a tax liability for your household
4) How much have you pre-paid through your payroll deduction?
If you paid in more than your tax, you get a refund
If you don’t pay in enough, you will owe at the end
It’s simply a situation of pay now or pay later
Here is the main issue….each payroll that is calculated at each job is independent. It is simply a computer calculating a % of tax withholding for the income that is being generated at that payroll location. The payroll at each job has no information about what other income is in the household from a spouse or a second job or other type of income.
As a taxpayer, you need to have an understanding of your overall effective tax responsibility and withhold enough out of each source of income as the income is earned to cover the taxes at the end. As your income gets higher or you add additional income from other sources, the additional income is taxed at a progressively higher and higher tax %. So additional part-time or investment income is taxed at the higher rate above your regular wages.
What should I select on my W4 at my job?
Here is the REAL problem with the new tax law. The IRS changed the withholding tables to take a lesser % for Federal taxes than it ever had before. So most taxpayers started to get more take home pay during the year, but did not realize that this added up to MUCH less paid in throughout the year. The philosophy for the IRS was to give people more money to spend during the year and also cut the tax rates. The goal was to break even or even owe a little bit at the end. The problem is….most taxpayers really hate to owe.
The new withholding % was lowered MUCH MORE than the tax rates. So yes, tax responsibility did go down, but the WITHHOLDING % WENT DOWN TOO MUCH. Most people get direct deposit and do not analyze their pay stubs. Very few people actually realized how much less they were paying throughout the year and easily got used to the slightly larger take home check. Not realizing that the maybe $40-$60 more per each paycheck was going to add up to several thousand dollars less paid into Federal taxes.
MARRIED versus SINGLE rate for withholding on the W4
The SECOND issue with the tax withholding is the fact that the tax responsibility for a married couple is almost EXACTLY the same as the tax liability for two single people. HOWEVER, if you choose MARRIED on your W4 at work, your employer will take MUCH LESS out of each check for NO REASON. You do NOT OWE less as a married couple. You have just paid in MUCH LESS. Unless one spouse does not work at all or you have several dependents to offset the tax, it is better to claim the SINGLE rate in order to pay in enough. It doesn’t make sense, but that is the problem with the IRS, they don’t really understand how much most taxpayers hate paying taxes at the end.
NEW W4 FOR 2020 - Even MORE confusing
The new W4 was created for 2020 because there are no longer exemptions on tax returns, so the old system of claiming a number based on the members in the household doesn’t really work anymore. For most I would recommend if you are married, just claim SINGLE, it is only a guideline and you will be happier if you like to get a little refund. I also recommend checking the box on the W4 that “there are two jobs” in the household, in particular if your spouse also works. It will just allow a little more to be taken out.
FIGURE OUT YOUR BREAK EVEN % FOR TAXES IN YOUR HOUSEHOLD
Again, taxes come down to pay now, or pay later. We can tell you the % you need to make sure is taken out of each paycheck in order to make sure you don’t owe. Either you can withhold close to this % and about break even or withhold a little extra and get a refund at the end of the year.
An easy way to adjust the amount withheld is just to choose an extra amount to take out of each check. If you owe $1200 at the end of the year and you are paid biweekly, this is $1200 divided by 26 pay periods, which means an extra $46 per check in order to break even. Or you can choose to round up a little for example $50-$60 per check to make sure your tax is covered. If you discover this issue part way through the year, you may need to adjust to the amount of pay periods left in the year.
Some taxpayers prefer to calculate the tax withholding so they “break even” and don’t give the IRS extra money every year. That is fine also, it’s a personal preference. We just want to help taxpayers to understand the situation they have so they can make adjustments if they choose.