While taxes affect you as soon as you’re born, most of us don’t even start thinking about them until the momentous day when we get our first paycheck. That’s when we come to the distressing realization that we don’t get to take home all the money we’ve worked so hard for. Uncle Sam is getting a piece of it, and sometimes it seems like it’s a very big chunk of change.
This is because of something called payroll withholding, which is basically pay-as-you-earn taxation. While the IRS trusts us to file our taxes accurately and on time, the U.S. Treasury finds it easier to pay for federal programs if it gets some of the money before April each year. So taxes are taken out of your wages before you receive the money, deposited in an IRS account and credited to you when you file your return.
Meet your W-4: You can’t get around withholding, but you do have some control over the amount. The easiest way to manage how much tax is withheld is through the information you provide on one of the first forms your boss gave you: the W-4.
The W-4 asks you to enter the number of allowances you want to claim. This number is what your employer uses to calculate the amount of income tax to withhold. An allowance represents, in large part, how many people depend on your income. Usually, you claim one allowance each for yourself, your spouse and each of your dependents.
You’re in control: However, you can adjust the number of allowances for your situation to avoid having too much or not enough tax withheld. For example, if you have a lot of deductions — several kids and big mortgage interest payment each month — these factors will reduce your final tax bill, so you may want to claim more allowances on your W-4 to cut the withholding taken from your pay and hang on to more of your money now.
If you figure your allowances correctly, when you file your return in April you should neither owe a great deal in taxes nor get back a lot through a refund. While some folks like getting a big refund, that strategy is not necessarily to your advantage. That extra money you send to the government is, in essence, an interest-free loan from you to Uncle Sam. You might want to consider taking that extra cash from reduced withholding and putting it into a savings account where it can earn more money for you. Of course, that creates a different tax consideration, but that’s another story.