How to Adjust Tax Withholding to Get More Money Per Paycheck

Every year, it seems like you get a tax refund.

It's a nice chunk of money. But, ever wondered why you always receive a refund?

Most commonly, you get a tax refund because you paid too much taxes throughout the year.

Now:

You might think that getting a large refund is a good thing.

If you are someone that has trouble saving up money, then a tax refund at an expected time of year may be useful for you.

However, when you take this approach to saving, just realize that you are letting the government hold on to your hard-earned money without the benefits of earning interest on this “loan” to them.

The fact is:

You can get paid more per paycheck throughout the year, instead of waiting for a refund after you file your tax returns.

To do this, you have to adjust the tax that is withheld from every paycheck.

What is Tax Withholding?

If you are an employee, tax withholding is the amount of federal income tax that is deducted from your paycheck each pay period.

Your withholding is based on the amount of money that you earn and the information that you give your employer when you complete your W-4 form.

A W-4 is a standard form published by the IRS that lets you tell your employer how much money you want to be taken out of your paycheck each pay period.

So:

You can choose to have a lot of money taken out each week or you can choose to have a smaller amount of money taken out each pay period.

You can even choose to be totally exempt from income withholding tax.

In this case, there will be no federal income taxes taken out of your paycheck.

You will want to be careful with this option, as you could end up owing quite a bit of money to the IRS if you underpay incomes taxes throughout the entire year.

If you get confused when completing your W-4, the IRS provides a free withholding calculator to help you determine the amount of money that should be taken out of your paycheck for income tax payments.

Why Adjust Your Tax Withholding

Simply, you don’t want to miss out on earning interest on your money or be penalized for being short on cash throughout the year (means you may pay more interest and late fees on your debt obligations or bills.)

For example, if you were to save up $1,000 to $2,000 at a bank that will pay 1% or 2% on your savings balance, you would actually earn extra money just by keeping your money in the bank (instead of with the government.)

But when you overpay on your income taxes, you are “saving” money with the government but aren't earning any interest on those overpayments.  

What's more:

You may be paying interest on other debt obligations like loans or credit cards, while the government holds your money without paying you any interest.

It doesn't have to be this way.

Adjust your tax withholding to get more money per paycheck. This financial maneuver can affect your personal cash flow -- making a difference you're in a bind or need more money.

On the other hand:

You don’t want so little deducted from your check that when it's time for you to file your income taxes, you will end up owing the IRS.

If it's more money than you can come up with, you could be charged penalties and interest for what you owe the IRS.

Finally, it's worth noting that when you owe the IRS, you must file by the normal tax filing deadline.

If you don't, your tax payments may be considered late by the IRS.  You may incur penalties that include failure-to-file, failure-to-pay, and additional interest charges.

However, if you don't owe any money to the IRS, you do not have to meet the regular filing deadline but you will forfeit your tax refund if you wait longer than three years to file for a given tax period.

How to Adjust Your Tax Withholding

In order to adjust your tax withholding, you will have to complete a new W-4 form with your employer.

You can ask your employer for a copy of this form or you can obtain it directly from the IRS website.

Nowadays, many employers even allow you to adjust your withholding with an online version of the W-4 form through an employee web portal. This can make it easy to access and update the form as often as you need to.

Use the IRS withholding calculator to help you determine the best way to complete this form based on your financial goals.

This calculator will ask you questions regarding your financial details:

• What filing status will you use on your 2022 Income Tax Return? (i.e. Single, Married filing joint return, Married filing separate return, Head of Household,  Qualifying widow(er))
• Can someone else claim you as a dependent on his or her tax return?
• Total number of jobs
• Total number of dependents
• Whether or not you contribute to a tax-deferred retirement plan
• If you/spouse will be 65 or over at by a certain date
• Details around Child and Dependent Care Credit/Child Tax Credit/Earned Income Tax Credit/Other Credits
• Gross wages, salary, and tips you expect to receive in the current tax year plus any bonuses or other income
• Federal tax payments from previous pay periods
• How often you are paid
• Estimate of your 2021 deductions (if you will use them)

IRS suggestion

Once you enter all the information the calculator requests, you will get a suggestion from the IRS based on your answers that looks something like this:

Based on the information you previously entered, your anticipated income tax for 2022 is $_________.  If you do not change your current withholding arrangement, you will have $_________ withheld for 2022 resulting in an overpayment/underpayment of $_________ when you file your return.

Then you will get a recommendation on how to update your W-4 to pay just the right amount:

• You should enter the following number of allowances on line 5 of your Form W-4:
  • For the only job you entered (which has a projected salary of $XXX,XXX): ______  allowances.

• Check the “SINGLE/MARRIED/Married, but withhold at higher Single rate.” box on your Form W-4.

In this scenario:

The IRS suggests that claiming are a certain amount of deductions will meet the income tax obligations sufficient (though you may get a small refund.)

This will ensure you get the least amount taken from your paycheck while still meeting your income tax payment requirements.

However, if you decide that you want more money taken out of each paycheck to get a larger tax refund each year, you would choose a smaller amount of deductions.

Keep in mind that the accuracy of this calculator depends on the accuracy of the information that you give it.

If you are unsure about some of the options presented in the calculator, consult with a tax professional who can give you proper guidance on what options to choose.

This way, the calculator can give you the best suggestions for the number of deductions and what boxes to check on your W-4.

When to Make Adjustments

The IRS suggests that, as an employee, you should check your withholding when your life circumstances change.

On a yearly basis, you should check on your income tax withholding to make sure that you are on track to pay the proper amount of income taxes and when they want to pay it —  that is, either throughout the year or during the end of the income tax filing season.

If you have a more complex tax situation you may need to double-check your withholding. The IRS suggests the following group of people may fall under this category:

• Two-income families.
• People working two or more jobs or who only work for part of the year.
• People with children who claim credits such as the Child Tax Credit.
• People with older dependents, including children age 17 or older.
• People who itemized deductions in 2021.
• People with high incomes and more complex tax returns.
• People with large tax refunds or large tax bills for 2021.

Special circumstances

As a general rule:

You should not have to adjust it very often.

But there are some circumstances when you may want to adjust your tax withholding:

• There are changes in tax legislation
• Your tax situation becomes more complicated
• You have a large change in income due to either job loss or receiving additional income from, say, an inheritance or the sale of an asset (stock, business, real-estate, etc.)
• You contribute more (or less) to tax-deferred retirement accounts in a given year
• You receive additional 1099 income
• You have a large financial loss or expense of some sort (personal or business)
• You have another dependent to claim
• You want to adjust your income for a particular pay period

Overall, adjusting your tax withholding can be a cash management tool that can help you plan better for your financial goals.

You simply have to know what your preferences are in terms of getting more money per paycheck or having a larger refund when you file your income taxes.

Either way, consult with a professional who can give you proper guidance on how you should adjust your tax withholding for your particular financial needs.