Though many people would prefer it wasn’t the case, in the United States, you’re required to pay federal income taxes on the money you earn throughout the year. The self-employed have to make estimated quarterly payments directly to the IRS, whereas wage earners who fill out form W-2 pony up automatically every pay period when their employers withhold a portion of their check to fork over to the IRS on their behalf.
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In most cases, they fork over too much in estimated taxes, which is why tens of millions of people look forward to tax refunds every spring to reload their bank accounts. However, smart taxpayers would rather break even than give the IRS a free loan.
Simply put, this tax year, if you’d prefer to meet your tax obligations while also keeping every penny that’s yours when you need it throughout the year, you’ll have to tweak the amount that your employer deducts.
While receiving a refund when you file your taxes can make your tax bill sting a little less, in the long run, it’s actually a savvier financial move to aim to break even. Here’s how to find the sweet spot right in the middle.
So, you want to give the IRS its due without giving the government a handout — but what’s the right amount to withhold from your check to break even? For reference, if you don’t earn more than the Standard Deduction of $12,950, you won’t have to file your income tax return.
“As with most questions in taxes, the answer is, it depends,” said Eric Bronnenkant, certified financial planner (CFP), certified public accountant (CPA) and head of tax at digital investment advisor Betterment. “There are taxpayers who exist all over the spectrum. On one end, people who make below the standard deduction typically pay no income tax and no withholding may be required.
“On the other end of the spectrum, someone earning a $100 million salary per year likely needs to withhold at the top tax bracket of 37% on virtually all of their income. For most people who are in between, it’s a little bit harder to figure out but there are tools and guidelines to help.”
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You are, of course, trying to break even, but if you have to err, err on the side of not shortchanging the IRS. No one wants to be their own tax liability when it comes to choosing taxes withheld.
“First, a key goal for withholding should be to avoid being subject to an underpayment penalty by withholding the lesser of at least 90% of what you owe in tax for the current year or 100% of what you owe on the prior year’s tax,” said Bronnenkant, who’s also a professor of taxation at Seton Hall University and was an author of the EY Tax Guide for seven years.
If you want to adjust the amount that your employer withholds from your check, you’ll have to submit a new W-4 form to your boss, and believe it or not, the IRS itself is your best bet for getting it right.
“The IRS has a handy tool to determine what to put on a W-4 and be on track to break even, and this is going to be the easiest and most accurate way to go about this,” Bronnenkant said in reference to the IRS’ Tax Withholding Estimator.
The tool lets you input all the variables that will lead you to your perfect paycheck deduction amount and comprehensible tax rate.
“Greater itemized deductions and tax credits will reduce the withholding amount,” Bronnenkant said. “A higher income from you and your spouse typically increases the expected withholding amount.”
The ultimate result is a pre-filled form W-4 ready to be printed out.
“Is the system perfect for all scenarios? No,” Bronnenkant said. “It is not designed for more complex tax situations — long-term capital gains tax, qualified dividends, pensioners without active other employment, etc. — but it is a great tool for the average taxpayer.”
The IRS recommends using its withholding tool and filling out a new W-4 every year. If you’re not cut out for that level of diligence, make sure that you at least recalculate your withholdings in the wake of dramatic life events.
So, if you want to ensure your employer withholds the right amount from your paycheck, you should fill out a new W-4 that accurately reflects your tax situation every year or every time your situation changes, full stop. Life changes that should be reflected in your tax forms would include getting married or divorced, having a baby, having a child aged out of dependent status, getting a new job, starting a side hustle or making other changes to your tax situation.
You can request and submit a W-4 to your employer at any time during the year. For the most accurate results, you should fill it out as close to the beginning of the year as possible — then the changes will affect all of your paychecks for the year. However, last-minute filers can still update this information quickly and easily.
Caitlyn Moorhead contributed to the reporting for this article.
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