Determining the proper amount of income tax withholding can be a confusing issue. This is mostly due to the Form W-4, which is filled out by wage earning taxpayers when they start a job or have a change in their family situation. But, for the majority of taxpayers that rely on their withholding to cover their taxes for the year (as opposed to other taxpayers that make quarterly estimated tax payments), an error in the W-4 can result in bad news on April 15.
Allowances
The W-4 revolves around the number of allowances a taxpayer elects. The withholding tables work on averages that assume taxpayers in certain income ranges with a specific family situation will need to withhold certain amounts. For example, a married couple that both work and have two children will have a different number of allowances than a single taxpayer. However, this is also where the number of allowances can be tricky, especially for married couples that both work, or when a wage earner has more than one job. Reading and completing the Personal Allowances Worksheet on page 1 of the Form W-4 will help taxpayers select the proper number of allowances.
Working couples
For married couples where both spouses work, or one spouse has more than one job, the taxpayer will find it helpful to complete the Two-Earners/Multiple Jobs Worksheet on page 2 of the Form W-4. This worksheet will ensure that, once the wages from all jobs are added together, there will be enough withholding. For example, a working couple where both make $60,000/year will have taxes withheld during the year based on a 25% tax bracket. However, when both sets of wages are added together, the couple is actually in the 28% tax bracket. The result is that the taxes withheld might not cover the actual tax liability on the couples 1040.
Credits
Another important factor to consider when calculating withholding amounts is how many tax credits the taxpayer will claim on their 1040. The best example is the credit for child and dependent care expenses. Remember that credits are a reduction in tax, meaning that if a taxpayer expects a credit on their return, they might not need to withhold as much during the year.
Manual method
Some taxpayers that have consistent income and deductions from year to year can calculate their withholdings manually. If a taxpayer knows that their tax liability will approximate $10,000 for the year, they can direct their payroll representative to withhold that amount evenly throughout the year. This is more complicated than completing the worksheets included with the Form W-4, and consulting with a tax adviser is recommended.
The IRS also has a helpful tool for taxpayers to calculate their withholdings online. The taxpayer can enter some simple information regarding their income and family situation and the website will recommend an amount of withholding for the year. It is helpful to have a copy of the most recent paystub handy when using this tool.