How to Adjust Tax Withholding from Your Paycheck

Accurately Calculate Your Withholding for Federal Income Taxes

Closeup of man writing on a tax form with pen
••• PhotoAlto/Eric Audras/Brand X Pictures/Getty Images

Dealing with your taxes is as much a matter of planning for next year as it is finishing and filing your tax return this year. Life isn't stagnant, and your income or deductions can change. But you can always adjust your withholding to avoid receiving too large of a refund or, even worse, owing a significant balance to the Internal Revenue Service come tax time.

Finding just the right level of withholding can be a tricky balancing act, particularly if you anticipate significant financial changes in the coming year, or major personal issues like getting married, divorced, or having a child. Some general rules of thumb and an understanding of the process can help, and the IRS provides a couple of interactive tools to help you along.

Why Would a Refund Be a Bad Thing?

Receiving a tax refund actually means you goofed with your withholding. You gave the IRS more from your paychecks than you had to—money that you could otherwise have spent on bills, pleasure, retirement savings, or investments.

The IRS held onto that extra money for you all year and is now returning it to you when you get a tax refund—without interest. It would have done you better in a simple savings account.

Disregarding Your Withholding Can Be Taxing

Calculating a level of withholding that's "just right" can sometimes take as much time as preparing your tax return, and a lot of people are inclined the skip the math. The easiest course of action is to claim either "single" or "married" with one withholding allowance on Form W-4, but this can be far from accurate.

Claiming just one exemption will often result in a tax refund, but there can be situations in which one withholding allowance isn't enough, such as if you had significant investment income or a greater tax obligation due to the alternative minimum tax.

The fewer allowances you claim, the more will be held from your paychecks. You'll end up with a refund if your actual tax situation doesn't result in you owing the IRS that much.

Conversely, you might claim numerous allowances, and your take-home pay will bloom and increase accordingly. But you'll end up writing the IRS a check at tax time for taxes due and possibly additional penalties if those allowances were too much to cover your actual tax obligation.

Calculating Withholding More Accurately

One way to adjust your withholding is to prepare a projected tax return for this year. Use the same tax forms you used last year, but substitute the current tax rates and income brackets. Calculate your income and deductions based on what you expect for this year and use the current tax rates to find out what your projected tax will be.

Now use the withholding calculator on the IRS website to see what the suggested withholding allowances are for your personal situation.

The Purpose of Allowances

Think of a withholding allowance as an exemption. Each one you claim effectively tells your employer and the IRS that you don't have to pay taxes on a portion of your income.

The IRS recognizes that it can be costly to support a family, which is why the tax code provides for standard and itemized deductions. These represent portions of your income that you don't have to pay taxes on. Your correct number of exemptions generally correlates with the number of mouths you're feeding with your paycheck each week, anticipating that you'll claim those deductions at tax time, and potentially other tax breaks as well.

The IRS also provides a personal allowances worksheet to help you get it right, but some common-sense rules generally apply:

  • 0 allowances: You might want to claim this if someone else, such as your parent, can claim you as a dependent.
  • 1 allowance: You might also claim one allowance if another taxpayer claims you as a dependent, or if you're single and work only one job.
  • 2 allowances: This might also be appropriate if you're single with one job, or if you're married with no dependents.
  • 3 allowances: You're a head of household filer with one dependent.
  • 4 allowances: You're married with one dependent.
  • 5 allowances: You're married with two or more dependents.

The number of dependents you're supporting is an important component of your analysis, as is how many streams of income are coming into your household, such as because you and your spouse both work.

These are general guidelines, not requirements. You can usually safely increase allowances based on your number of dependents, or claim fewer if you have additional sources of income that aren't subject to withholding. It doesn't mean that those sources aren't ultimately taxable simply because they're not subject to withholding.

Calculating the Effect on Your Paychecks

Now that you've figured out your withholding allowances, you can use this number to see what the tax impact will be on your next paycheck.

Plug your newly calculated withholding allowances into a payroll calculator. Make sure you have a recent pay stub handy so you can use your actual income amounts. You're just changing allowances upward or downward.

Calculating Your Total Withholding for the Year

Take your new withholding amount per pay period and multiply this by the number of pay periods remaining in the year. Add in how much federal income tax has already been withheld so far year-to-date. The total represents approximately how much total federal tax will be withheld from your paycheck for the year.

You can now compare your total withholding to your tax liability projection. If your withholding amount is larger than your tax liability, that's how much of a federal tax refund you can expect to receive. If your withholding is less than your tax liability, this is how much federal tax you might have to pay when you file your tax return.

Remember, these amounts—your withholding and your tax liability—are approximate. You're close to where you need to be if they're not too far apart.

Ask yourself if you can easily write a check to the government plus a little interest if your calculations show that you're going to owe the IRS $500 in April. Now is the time to adjust if you can't.

Adjusting Your Withholding 

Go back to the payroll calculator to fiddle with your withholding allowances. Try "single" instead of "married," or try changing the withholding allowances by one point at a time. For example, try a new calculation with Single-3 if you used Single-4 the first time. 

Repeat this process until you find the withholding level that's right for you. Ideally, your withholding will produce a refund in the $500 to $1,000 range. This gives you plenty of room so any changes in income or deductions won't result in you owing very much at tax time.

The Bottom Line

There's no rule or law that equates an exact number of allowances to each taxpayer based on filing status and dependents.

You're free to change your allowances at any time during the tax year if you think you might have gotten them wrong. In fact, you can change them multiple times even if you think you got things right but then your circumstances change.