Tax season typically has two outcomes: a refund, which is fun, or owing money, which is not.
While getting a tax refund is nice, it really means you’ve had too much of your income withheld from your paycheck throughout the year. Essentially, it’s money you overpaid to the government, which is why you get it back. Similarly, if you owe money after doing your taxes, it means that too little has been taken out of your paychecks. The ideal outcome here is to come as close to $0 without actually owing anything extra, and a lot of that depends on how much money is withheld from your paychecks.
So what is the ideal amount to withhold from your paycheck? It depends on your income, but there is a simple formula you can apply that helps determine the exact amount that you should have withheld from your check. Here’s a look at how to apply that formula to your situation, and hopefully make tax season a little less hectic in the future.
Total Your Tax Withholdings
First, take a look at a recent paystub and find out what you’re currently having withheld. After finding that amount, multiply that by the number of paychecks you get per year. So if you have $100 withheld and are paid at the end of every month, multiple 12 X 100 for a total of $1,200.
If you’re married and/or filing jointly, you’ll want to make the same calculation for your spouse’s income. Once you have the two totals, simply add them together. This is the amount you’ll want to be withheld. Keep in mind this only applies to federal income tax, and the rates will vary depending on which state you reside in.
Estimate Your Tax Liability
Knowing your estimated withholdings, the next step is to figure out what you’ll owe in taxes this year. The IRS has worksheets available online for this, which is really a lot like doing your taxes before actually doing your taxes — but think of it as being extra prepared. That and it’s an important step when it comes to making sure you’re not withholding too much (or too little) from every paycheck.
Obviously, the specifics will again vary based on individual incomes. For example, if a couple makes just over $100,000 a year together, that would mean they’d end up owing about $9,600 in federal taxes. The goal at this point is to make sure what they each have withheld from their respective paychecks is as close to that $9,600 figure without going under — which would mean owing money.
Adjust Your Withholding
Assuming you’re withholding too much, or too little, from your income, you’ll want to readjust your paycheck accordingly. First, fill out and submit an updated W-4 to your employer. These updated W-4 forms even have an option to allow for additional amounts to be withheld, so you can use that to your advantage here. If you’ve been at your current job for a while, it might not be a bad idea to update your W-4 anyway.
Don’t Forget Additional Income
Of course, all this information is only applicable to W-4 employees, and not any sort of 1099 or contract work, which won’t have any taxes taken out ahead of time. Anyone who makes more than $400 in freelance work in a calendar year will owe taxes on it.
The rule of thumb is to set aside 25%-30% of your earnings. It’s a significant amount, which is due to the fact that under tax law, you’re considered both the employer and the employee. While the self-employment tax is 15.3%, having more than you need when the taxes are due is a far better alternative than not having enough.
You can also pay freelance income taxes quarterly, which is recommended if you typically owe $1,000 or more. If you owe less than that, then the taxes can simply be paid when filing your annual tax return. As always, the IRS also has forms available online to help navigate this process.
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