Monday, November 27, 2006

Changing Your Tax Withholding

Why is it that pretty much everyone around me thinks that over-withholding on federal income taxes is the right thing to do?

"It makes me save money," a coworker told me once. "If I don't do it this way, I'll never save anything."

"But when you get the refund, what happens?" I asked.

"Well, I think we use it to pay credit-card bills," he said. "Let me call my wife to find out . . .."

And so it goes. Over the course of the year, he's loaning his hard-earned cash to Uncle Sam at the fine rate of zero percent interest. Meanwhile, his credit-card bills are accumulating interest at a rate of anywhere from 8 to 20-something percent annually. Does this sound like a smart thing to do? Loaning money out at zero percent, while borrowing it at 15 percent? (And this doesn't even factor in the money you're also "losing" to inflation.)

Well, it's not.

Consider, also, the case of a single mom we know. Money, as is almost always the case with single parents, is super-tight around her house. When we sat down one day to analyze her spending and draw up a workable budget, we discovered that Single Mom's monthly expenses, versus her income, were such that she would be significantly in the red every single month. How had she managed to get by to this point?

You guessed it: credit cards.

"But I pay it all off when I get my tax refund," she said. "It's always several thousand dollars. At least."

Up to that point, we had been brainstorming ways to (1) cut her expenses and (2) boost her income. But here, in the blink of an eye, was a fantastic First Step: She needed to adjust her tax withholding and thus get more income in her hands at each paycheck. She needed to stop loaning the government money FOR FREE.

As a single mom with two boys, she needed the cash much worse than the Feds did.

And she didn't need it next year. She needed it now.

Employers: Uhh ... You're Not Helping

I'm training two new people at my Day Job, and I've come to discover that both of them (1) carry high-interest debt of some sort, yet (2) love getting their several-thousand-dollar tax refunds each year.

This just doesn't make any sense. Really.

With my employer, Standard Operating Procedure dictates that all new hires attend Employee Orientation in their first week of employment. It's held at our corporate office, of course. And someone from said corporate office uses the meeting to talk about the company's Storied History, its Locally Reknowned Family Atmosphere, and all the rest of that drabble that Corporate folks love to revel in, but which has Mostly Negligible Value in the Real World. Plus they dole out employee handbooks and W-4 forms.

Guess what instructions our Corporate Office dispenses when they hand out the W-4s? It goes mostly like this:

"You guys just sign and date these at the bottom and turn them in. We'll take care of the rest."

What this tells me is that Upper Upper Management is too lazy to want to mess with the "headaches" that stem from employees actually filling out their W-4s correctly — meaning, with anything other than zero allowances.

How should they handle this? Here's what I found in Section 9 of the IRS' Publication 15 - Employers Tax Guide regarding employers and how they should handle Form W-4s with their employees:

To know how much federal income tax to withhold from employees' wages, you should have a Form W-4, Employee's Withholding Allowance Certificate, on file for each employee. Encourage your employees to file an updated Form W-4 for year 2xxx, especially if they owed taxes or received a large refund when filing their 2xxx tax return. Advise your employees to use the Withholding Calculator on the IRS website at for help in determining how many withholding allowances to claim on their Form W-4.

Ask all new employees to give you a signed Form W-4 when they start work. Make the form effective with the first wage payment. If a new employee does not give you a completed Form W-4, withhold income tax as if he or she is single, with no withholding allowances.

So my employer isn't breaking the rules, strictly speaking. They're just taking the easy way out. They're not offering all the information, or telling the whole story.

Adjusting Your Withholding: Where to Start

Okay. So if you need to adjust your tax withholding, check out the resources below — they can take the guesswork out of adjusting your allowances on your Form W-4.



— Posted by Michael @ 8:26 AM


Yeah it's pretty ridiculous the reasons people come up with for overwithholding, but I think we (as in fiscally responsible people) have to realize that some folks don't have as much discipline. They see a positive number in their bank account and think they have to spend it.


I often tell people at work the same points you bring up even some in management/leadership positions and they look at me like I am nuts. I usually owe about $20 tax time. I should probably review my form since I have left it the same since i started.


I agree with Jim, discipline is the key here. When you do not excerise it you are giving yourself permission to live above your means.

Some people are not comfortable having money saved in the bank. they feel that money should be spent on something.


i prefer to spend cash instead of credit card . i think it helps in saving


Great post. Agree 100%. A good target is to withhold a little more than what was paid the previous year, and still need to pay some. By withholding more than the previous year's payment, one will avoid any penalties for under withholding.


Everyone I know this year needed to pay out more in taxes than was withheld. We claimed exactly one exception for myself and then for my husband. We owe an additional $943 in taxes, which is almost exactly the amount of money we'd manage to save that year. This year, I'm having them withold at the singles rate.

The thing for me is, if those exceptions do not ensure that it takes out enough to cover your taxes, then why don't they adjust them? What's the point after all with choosing one or two exceptions, based on the number of people in the household and then finding out that you somehow need to come up with even more money to give to the gover nment? It's part of what you left out in the post. Most folks have them take out too much in taxes because they can't afford to come up with more money to pay taxes if they are wrong.


I think the answer to your question, Teri, rests in the fact that our tax system is a complicated mess. Which is why the W-4 calculators I link to above are necessary.

Like you, I've learned this much: Relying on allowances and exemptions usually won't get us where we want to go.


I use tax software. When I'm finished with my tax return and have saved it, I then save a copy that I name 20xx planner,xx being the new tax year. Then, using the planner, I enter my projected income for the year from my annuity statement (I'm retired, but if you're still working, use your latest pay stub and multiply gross pay, fed tax and state tax by 12). Then I project my deductions, using last year's tax return. Try to be as accurate as possible with this step. You can use an amortization table to estimate your mortgage interest. If you're diligent, you can get close to 99% of what you're return wil be like next year. Then, let the software calculate your taxes. The results will then determine the amounts that you need to use on your federal and state withholding forms. A final note: I adjust my withholdings so that I get back a little over $100.00 in refunds on both federal and state taxes. This allows for changes in IRS rules from the previous year. Works great for me!,

Anonymous Anonymous
, at 3:27 PM, March 19, 2007  
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