Most taxpayers get refunds every year. And a lot of them do so because they have too much withheld from their paychecks.
But such overwithholding is bad. You're giving the federal government an interest-free loan of your money for the year. The IRS would never reciprocate by giving you one, and in fact imposes stiff penalties and fees to those who don't file or pay on time.
Underwithholding, which means you'll owe the IRS when you file your annual 1040, isn't recommended either. If you owe a lot when you file your return, you could even face underpayment penalties.
Ideally, you want to have just enough withheld so that the amount will come as close as possible to your actual tax liability for the year.
Filling out the W-4
The Form W-4 is short, but not all that simple to folks with complex lives. This step-by-step explanation will help.
It's easy to do.
First, look at your prior year's tax bill. If the amount you had withheld was very close and you haven't had any major lifestyle changes, then leave your payroll withholding alone.
But if you owed a lot or got a big refund, then it's time to adjust your withholding.
You also might need to fine-tune your workplace taxes if things in your life have changed substantially. Did you get married, have a child, buy a house or receive income that's not subject to withholding, such as interest income or capital gains profit? These will affect your eventual tax bill, so you need to account for them in your withholding amount.
Fine-tuning your W-4 You can make the changes any time during the year by simply going to your payroll office and filing a new W-4. This is the form your employer uses to calculate how much in taxes will be taken from each paycheck.
The more allowances you claim on your W-4, the less income tax will be withheld. The fewer claimed, the larger the withholding amount.
To help you determine the correct number of allowances, you'll find an eight-line Personal Allowances Worksheet. It's actually the first part of the Form W-4. If you have only one job, are single or married to a nonworking spouse, and don't itemize, the W-4 process is fairly simple.
You get one allowance for yourself, your spouse and one each for your children or other dependents.