What is the best way to calculate the optimal tax withholding from my paycheck?

Question

My tax refund for this past year (United States) was much higher than I would have liked it to have been.

I'm single and have no dependents.

My tax refund was about 4% of my salary. Is that normal?

Could I claim myself as a dependent?

MrChrister worded it better than I did: I want a smaller refund, thereby getting more money in each paycheck. I am not asking to lower my tax obligation, but limit the "free loan" I give to the IRS.

Answer 1

First you must understand your Marginal Tax Rate (Tax Bracket) The exemptions you claim are like saying to your employer "tax me on $4050 less, or more" for each change up or down of 1 exemption.

Say you look at the table (2016 tables at my main site) and see you are in the 15% bracket. And your refund is $2000. 2000/.15 is $13,333. So you want that $13K to not be taxed. Raising exemptions by 3 (3x4050 = 12,150) will get you close. $1822 closer to your goal.

For what it's worth, you can read through the instructions for the W4, of course. But this answer skips through the details and gets you to your goal.

One point to note, since the exemption is in whole numbers, and $4050 is it, you will get close, +/- $608 if in the 15% bracket, but to get dead on, you'd need a mid year adjustment. Not worth it. A refund of under $608 should be enough for a 15%er. ($1012 for a 25%er) If you ready want to nail the taxes to a closer accuracy, you can use the line requesting additional dollars be withheld.

Most W4 discussions miss this point.

The exact number withheld by your employer comes from an IRS document known as Circular E, but retrieved as Publication 15. It will help you confirm the validity of my dirty shortcut method.

What I do recommend is that you use a quick online tax calculator to do a dry run of you return, early in the year. If you see your withholding is off in either direction, best to adjust as soon as possible.

(The numbers here now reflect 2016's $4050 exemption, recent question on Money.SE have linked to this one, prompting me to update for 2016)

Answer 2

What you need to do is to reduce the withholding from your wages, or pay a smaller amount in your quarterly payments of estimated tax (if you are self-employed). To reduce withholding from wages, fill out a new W4 form (available from your employer's HR department). There is a worksheet in the form that will help you figure out what to write on the various lines. As a single person, you are entitled to claim an exemption for yourself, and if you have not been claiming that exemption, doing so will reduce your withholding, and presumably your tax refund.

Answer 3

In short, I suggest you take a look at your W-4 form and adjust it properly. And yes you can claim your self as a dependent, unless someone else is claiming you.

But here is a more detailed explanation of how it works.

How Income Tax Works.

While most people tend to only think about the tax system and the Internal Revenue Service (IRS) as the month of April approaches, it's actually a never-ending process. For our purposes, a good way to explain how the system works is to give an example of one American income earner, we will call him Joe.

The tax process begins when Joe starts his new job. He and his employer agree on his compensation, which will be figured into his gross income at the end of the year. One of the first things he has to do when he's hired is fill out all of his tax forms, including a W-4 form. The W-4 form lists all of Joe's withholding allowance information, such as his number of dependents and child care expenses. The information on this form tells your employer just how much money it needs to withhold from your paycheck for federal income tax. The IRS says that you should check this form each year, as your tax situation may change from year to year.

Once Joe is hired and given a salary, he can estimate how much he will pay in taxes for the year. Here's the formula:

1. Start by assessing gross income, which includes work income, interest income, pension and annuities.
2. Subtract any adjustments (examples: alimony, retirement plans, interest penalty on early withdrawal of savings, tax on self-employment, moving expenses, education loan interest paid). The difference is the adjusted gross income (AGI).
3. Once the AGI is calculated, there are two choices: Either subtract a standard deduction, or subtract itemized deductions, whichever is greater. Itemized deductions might include, but aren't limited to, some medical and dental expenses, charitable contributions, interest on home mortgages, state and local taxes and casualty loss.
4. Next, subtract personal exemptions to end up with taxable income.
5. Go to the IRS tax tables if taxable income is less than $100,000, or to the IRS tax rate schedules if it's more than $100,000. This is where it gets a little complicated, because the United States uses a marginal tax rate system. There are six tax brackets: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. How the tax rate works depends on income and marital status. For those using the tax table, look for taxable income on the chart to find gross tax liability. For those making more than $100,000, use the tax-rate schedule to figure gross tax liability.
6. From your gross tax liability, subtract any credits. Credits may include such items as child care. The difference is the net tax, which is how much to pay or how much of a refund to expect.

At the end of each pay period, Joe's company takes the withheld money, along with all of withheld tax money from all of its employees, and deposits the money in a Federal Reserve Bank. This is how the government maintains a steady stream of income while also drawing interest on your tax dollars.

Toward the end of the tax year, Joe's company has to send him a W-2 form in the mail. This happens by January 31. This form details how much money Joe made during the last year and how much federal tax was withheld from his income. This information can also be found on Joe's last paycheck of the year, but he'll need to send the W-2 to the IRS for processing purposes.

At some point between the time Joe receives his W-2 and April 15, Joe will have to fill out and return his taxes to one of the IRS service and processing centers. Once the IRS receives Joe's tax returns, an IRS employee keys in every piece of information on Joe's tax forms. This information is then stored in large magnetic tape machines. If Joe is due a tax refund, he is sent a check in the mail in the next few weeks. If Joe uses e-File or TeleFile, his refund can be direct-deposited into his bank account.