In this article, we are going to talk about how to change your tax withholding so that you reduce or eliminate your tax refund that you get each year from the IRS.
If you want to invest and improve your wealth and finances, start with saving money. One area where you can save more money is to tell the IRS to increase your take home pay. The default setup for most people is that they over pay taxes to the IRS and get a refund at the end of the tax year. Is it possible to get more money in each paycheck? Yes, and not only that. The IRS not only will let you adjust this, they also tell you how to do it! We talk about this IRS tool.
When you get a tax refund, you are essentially loaning money to the IRS. It is possible to earn 5% on your money so you should keep more of what you earn. Not only that but you can overwithhold and borrow up to 10% of what you owe in taxes from the IRS.
Tax Withholding Strategy
We are going to review how to use the IRS withholding tool that will instruct you how to adjust your withholding to get you to even. So, if you owe $10,000 in taxes, but expect to pay $12,000, the tool will tell you how to adjust your 1099 with your employer to reduce your tax withholding so that you only pay $10,000.
The tool is also intelligent enough to adjust the amount based upon what you have already paid during the year.
For example, on April 15th, you have already gotten about 7-8 paychecks (assuming you get paid every two weeks). The paychecks already deducted taxes based upon the higher tax deception level. To compensate, the rest of the year you need to reduce your withholding even more.
Note that the following year you should adjust your withholding again In January. This is because the reduced withholding will be withholding too much when calculated for a full year.
As shown in the chart here, if you adjust your withholding on April 15th, you want to do it again on January 1st. The reason is that the April 15th change will lower your withholding more because it covers only 3/4 of the year. Once the new year commences, you would want to adjust it so that the withholding covers the entire year.
A Sample Taxpayer
For the demo we are going to use the above example as a taxpayer. We assume they make $100,000/year. Also, we have added $1,000 of investment income. These are pretty basic assumptions, the calculator is actually quite detailed to cover many different situations. We won’t go into more complicated situations, but if these apply to you, make adjustments as necessary.
There is $700 of income tax deducted per pay period. This ends up being $3,433 too high. At the end of the year, this is the amount of the refund that would be expected. Follow along as we enter this information into the IRS tool.
Using The IRS Withholding Estimator
Click on this link to get the the IRS Withholding Estimator
This is the first screen that has basic taxpayer info, we will fill it in.
The next screen specifies that you are paid every two weeks and that you worked all year long.
The next screen we enter salary information per pay period. We enter a date of 4/12/2024 as the last pay period, which is reasonable since it is in the middle of the month on a Friday. We copied the info from the first chart in this article. Also, on this screen we added the $1,000 of investment income, such as what you might have earned from bank interest.
The next screen we take the standard deduction, we assume they are not itemizing expenses.
We jump ahead to the end, since we didn’t need to enter any Tax Credits. We get the summary screen, which shows the estimated refund ($3,433).
In this screen, you can click on ‘Download Pre-Filled W4 Form’. you will get the following form filled out.
The key number is in Step 3: $1052. This is the total amount that will bring your refund to $0. You can increase this amount to get a “loan”, which would cause you to pay the balance when you file your taxes. The maximum you could “borrow” (90% of your tax owed) without penalty in this case would be $1,395.
We have also run the calculation as if you started from the beginning of the year. (This result is in the first section). Because the withholding is spread out during the whole year (instead of 8 months), the Step 3 adjustment would be $356.