How to Adjust Tax Withholding From Your Paycheck

Accurately calculate your withholding for federal income taxes

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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 (IRS) come tax time.

Finding just the right level of withholding can be a balancing act—particularly if you anticipate big changes in the coming year—or personal events with tax implications, like getting married or divorced, or having a child. Some general rules of thumb and an understanding of the process can help. The IRS provides some interactive tools to help you along.

Why Would a Refund Be a Bad Thing?

Receiving a tax refund actually means you gave the IRS more from your paycheck 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 served you better in a simple savings account.

New Withholding Form

Calculating a level of withholding that's just right can sometimes take as much time as preparing your tax return. The IRS introduced a new Form W-4 that covers tax year 2020 moving forward. It aligns with changes made by the 2017 Tax Cuts and Jobs Act that eliminated the personal exemption, which tied into allowances. The new form aims to simplify the process and uses a question-and-answer format. It allows you to adjust withholdings upward or downward.

If you expect significant investment income or have other outside income not subject to withholding, you can have more withheld from your paycheck to cover it at tax time. If you overwithhold, you'll get a refund. Alternatively, if you adjust your withholding amount too far downward, you will owe the IRS at tax time and could also incur a penalty.

Paying at least 90% of your tax owed is usually enough to escape the estimated tax penalty.

Calculating Withholding More Accurately

One way to adjust your withholding is to prepare a projected tax return for the year. Use the same tax forms you used the previous 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 determine your projected tax.

Then, use the withholding calculator on the IRS website to see the suggested withholding for your personal situation. The number of dependents you support is an important component of your analysis, as is the number of streams of income.

Calculating the Effect on Your Paychecks

Once you've figured out your withholding, you can use this number to see what the tax impact will be on your next paycheck. Plug your newly calculated withholding information into a payroll calculator. Make sure you have a recent pay stub handy so that you can use your actual income amounts.

Calculating Your Total Withholding for the Year

Take your new withholding amount per pay period, and multiply it by the number of pay periods remaining in the year. Next, add in how much federal income tax has already been withheld year-to-date. This total represents approximately how much total federal tax will be withheld from your paycheck for the year.

Ask yourself whether 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.

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, that's 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. You're free to change your withholding at any time during the tax year if a change in your circumstances would result in a tax increase or decrease.

Frequently Asked Questions (FAQs)

How do you change the tax withholding on SSI checks?

You can change your tax withholding on Social Security income, unemployment compensation, and other kinds of government benefits with Form W-4V.

What is the average amount of taxes taken out of a paycheck?

The average tax wedge in the U.S. was about 28.29% in 2020. The tax wedge isn't necessarily the average percentage taken out of someone's paycheck. Someone would need to pay just the right amount of taxes so that they wouldn't owe or get a refund when they file their tax return—in that case, the average rate of 28.29% would apply.