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I live in Pennsylvania.

They take out about $750 per paycheck as of right now. I recently changed the allowances that I had from 0 to 3. It had no effect whatsoever on my take home pay. And I had 0 allowances last year as well, and I ended up owing close to $1300 in taxes this year which I just got through paying off last month!!

Am I forever doomed in tax hell?!

Thanks.

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Did you have 0 allowances on your tax return as well? If so why are you not at least claiming yourself? –  user4127 Jul 20 '12 at 14:18
    
I had 0 for at least a year now. I had no clue about allowances until like last week. I just figured it out and changed it and I still got the same amount in my paycheck :( –  DmainEvent Jul 20 '12 at 16:00
    
What you claim with your employer will balance itself out as long as you do it properly when you return. Of course, then the government is getting the interest on your funds throughout the year until you get your refund in April (or whenever you file). I knew a guy who claimed as little as possible so he could get a giant refund when he filed. He didn't like my suggestion of auto-moving funds into a savings account, for some reason. "Too hard to set up" or something? :p –  corsiKa Jul 20 '12 at 16:31
    
@DmainEvent: Because you owed $1300 in April 2012 are you having to file quarterly this year? –  mhoran_psprep Jul 21 '12 at 3:43
    
The irs didn't mention anything about filing quarterly. –  DmainEvent Jul 21 '12 at 12:48

3 Answers 3

up vote 12 down vote accepted

Take a look at IRS Publication 15. This is your employer's "bible" for withholding the correct amount of taxes from your paycheck. Most payroll systems use what this publication defines as the "Percentage Method", because it requires less data to be entered into the system in order to correctly compute the amount of withholding.

The computation method is as follows:

  1. Compute the employee's gross pay for the pay period (wages, tips, salary, commissions, etc).
  2. Subtract any "pre-tax deductions" (med ins premiums, retirement, etc). This is the employee's "pre-tax net pay".
  3. Divide the amount one W-4 allowance is worth annually (for 2012, that's $3800) by the number of pay periods in the tax year (e.g 26 for bi-weekly). Multiply this by the number of allowances claimed on the W-4 and subtract it from the pre-tax net pay to determine the "pay subject to withholding".
  4. Taxes are computed "piecewise"; dollar amounts up to A are taxed at X%, and then dollar amounts between A and B are taxed at Y%, so total tax for B dollars is A*X + (B-A)*Y. Here is the table of rates for income earned in 2012 on a daily basis by a person filing as Single:

    More Than   But Less Than   W/H Base   W/H Pct
       0.00        8.30           0.00      0%
       8.30       41.70           0.00     10%
      41.70      144.20           3.34     15%
     144.20      337.70          18.72     25%
     337.70      695.40          67.10     28%
     695.40     1501.90         167.26     33%
    1501.90                     433.41     35%
    

    To use this table, multiply all the dollar amounts by the number of business days in the pay period (so don't count more than 5 days per week even if you work 6 or 7). Find the range in which your pay subject to withholding falls, subtract the "more than" amount from the range, multiply the remainder by the "W/H Pct" for that line, and add that amount to the "W/H Base" amount (which is the cumulative amount of all lower tax brackets). This is the amount that will be withheld from your paycheck if you file Single or Married Filing Separately in the 2012 TY. If you file Married Filing Jointly, the amounts defining the tax brackets are slightly different (there's a pretty substantial "marriage advantage" right now; withholding for a married person in average wage-earning range is half or less than a person filing Single.).

In your particular example of $2500 biweekly (10 business days/pp), with no allowances and no pre-tax deductions:

$2500 / 10 = $250 // you're in the 25% bracket
$144.20 * 10 = $1442.00 //amount taxed at lower rates incl. in W/H base
$18.72 * 10 = $187.20 //W/H base for $1442.00
$2500 - $1442.00 = $1058.00 //Amount subject to 25% tax
$1058.00 * .25 = $264.50 //Addtl tax for 25% bracket
$264.50 + 187.20 = $451.70 //Total Fed W/H

So, with zero allowances, your employer should be taking $451.70 out of your paycheck for federal withholding. Now, that doesn't include PA state taxes of 3.07% (on $2500 that's $76.75), plus other state and federal taxes like SS (4.2% on your gross income up to 106k), Medicare/Medicaid (1.45% on your entire gross income), and SUTA (.8% on the first $8000). But, you also don't get a refund on those when you fill out the 1040 (except if you claim deductions against state income tax, and in an exceptional case which requires you to have two jobs in one year, thus doubling up on SS and SUTA taxes beyond their wage bases).

If you claim 3 allowances on your federal taxes, all other things being equal, your taxable wages are reduced by $438.45, leaving you with taxable income of $2061.55. Still in the 25% bracket, but the wages subject to that level are only $619.55, for taxes in the 25% bracket of $154.89, plus the withholding base of $187.20 equals total federal w/h of $342.09 per paycheck, a savings of about $110pp. Those allowances do not count towards other federal taxes, and I do not know if PA state taxes figure these in.

It seems odd that you would owe that much in taxes with your withholding effectively maxed out, unless you have some other form of income that you're reporting such as investment gains, child support/alimony, etc. With nobody claiming you as a dependent and no dependents of your own, filing Single, and zero allowances on your W-4 resulting in the tax withholding above, a quick run of the 1040EZ form shows that the feds should owe YOU $1738.20. The absolute worst-case scenario of you being claimed as a dependent by someone else should still get you a refund of $800 if you had your employer withhold the max. The numbers should only have gotten better if you're married or have kids or other dependents, or have significant itemized deductions such as a home mortgage (on which the interest and any property taxes are deductible). If you itemize, remember that state income tax, if any, is also deductible.

I would consult a tax professional and have him double-check all your numbers. Unless there's something significant you haven't told us, you should not have owed the gov't at the end of the year.

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+1, Very informative answer. The OP worked as an independent contractor and had SE income, that was probably the reason for underpayment. –  littleadv Jul 23 '12 at 22:44
    
Ah, yes. If whoever he was working for didn't "employ" him, then he'd be paying the employer side of payroll taxes plus employer halves of Medicaid, FUTA and SUTA. That would, indeed, be "tax hell" IMHO. –  KeithS Jul 23 '12 at 22:47
1  
Good gravy, that is what I call a good answer. I may need to read that several times before I take my GMAT's. If I am not mistaken that post has about all I need to know. But to get back to the subject, I did consult a tax professional at Turbo-tax... who basically told did the same calculations that I did (rip-off) and we got to the same number. The problem is that I worked as a independent contractor for 2 months of the year, so I effectively didn't pay taxes for 2 months that year. –  DmainEvent Jul 24 '12 at 15:06
3  
If you end up doing any more independent contracting it is a good idea to pay estimated taxes. You can pay them once per quarter, and it helps to avoid this kind of unpleasant surprise at tax time. –  Justin Ethier Jul 25 '12 at 13:34
1  
Now, there are some gotchas built into the tax code. You can't, for instance, claim so many exemptions that you end up owing more than $10k in taxes (even if you have no problem paying that much in April). The IRS wants that money in their coffers to ensure good cash flow. There's no maximum to how much the IRS will refund (so you could have your employer withhold 100% of your paycheck by specifying an additional amount equal to or greater than your net pay), but large refunds are an audit trigger. –  KeithS Jul 30 '12 at 20:34

It will usually take a week or two for changes to your withholding to take effect in payroll. However 0 deductions will withhold more per check than 3. So if at 0 deductions you are having to pay in April then I would suggest not changing your W2 to 3 deductions. Instead in the section for extra with holding add $25 per week. This should leave you with a more manageable return in April.

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I propably should have been more specific, but I was working as an independent contractor for 2 months of last year before I went full time. That probably contributed to my large deficit this time around. But is there anyway to figure out what percentage you should recieve if you have a withholding? –  DmainEvent Jul 20 '12 at 16:47
    
@DmainEvent - My experience is unless you have income from outside of your primary employer claiming 1 is a pretty safe bet. If you have other jobs claiming 0 should handle any extra taxes because of higher bracket earnings. –  user4127 Jul 20 '12 at 19:24

I use paycheckcity.com and first punch in my paycheck and make sure it calculates within a few pennies the value of my actual paycheck.

Then I fiddle with withholding values, etc. to see the effect of change. It has been very effective for me over the years.

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