According to the IRS the average tax refund is around $3,000, which means taxpayers overpaid by that amount. Imagine what that amount could do for you if you had it during the year.
Your federal tax withholding is the amount that is kept by your employer from your income every time you’re paid and handed over to Uncle Sam for your tax liability each quarter of the year. Most people associate their tax withholding to the combination of their filing status (single, married, etc.) and the number of exemptions they claim on a W-4 form.
The more exemptions you claim means the less that will be taken out as your tax withholdings. However, claim too many exemptions, and you’ll be paying when tax time comes around. So finding the balance is key.
Why You Should Adjust Your Withholding
Some taxpayers prefer to receive their refund each year, but don’t realize they are actually losing money with this approach. How can we say that? Well there are a few different things you can do with the extra money during the year that will give you more by the end of the year. Here are some ideas:
- For the short-term – A simple savings account with an interest rate of 1% compounded annually for a year would result in a final total of $3,014.74.
- For the short-term, but riskier – Consider a brokerage account, or a self-guided investing account. While you may pay fees for transactions for some, there are a number of different options and services. Some services offer the assistance of a broker for an additional fee. Your earning potential here is much higher, but again the risk is higher because you’re buying stocks.
- For the long-term – An IRA or retirement account could yield the greatest payoff. However, you would not have access to the funds until you reach retirement age without incurring a fee or taxes for early withdrawals.
How to Adjust Your Withholding
The next step is to understand how to adjust your federal tax withholdings to as close to zero as possible. The good news is there is a simple tool to help, the IRS’s Withholding Calculator. Consider whether you want to lean on the side of caution and receive a small return – maybe $100, or owe slightly. Your choice will determine how many exemptions you should claim.
Why Do I Still Owe Taxes?
If you have two part-time or hourly jobs, and find yourself owing taxes every year, it may be because your multiple incomes together place you in a higher tax bracket. However, since you’re taxed on your individual incomes, the amount you pay once combined may not meet your tax liability of the combined incomes. Here’s an example based on the 2014 income tax brackets and filing single:
- Job 1 – You made $18,000 last year. Your federal income tax liability with no exemptions would be $2,246.
- Job 2 – You made $20,000 last year. Your federal income tax liability with no exemptions would be $2,546.
- Combined – You made $38,000 total. You paid $4,792 so far, however since the $38,000 places you in the 25% tax bracket, you would actually owe $5,356. Therefore, you would owe the difference come tax time.
To fix this issue, you can use your previous year’s earnings to set your withholdings, and elect to have additional withholdings taken to make up for the difference on your W-4.
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