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I'm getting a head start on this year's income taxes for my wife and I. I have my W-2 already and I have her last paystub for the year.

I claimed one exemption on my W-4, and according to her paystub, she claimed zero. We do our taxes married filing jointly, and have no dependents. We both work full-time.

Somehow, we still owe $500 according to my tax software.

How is this possible? I would have assumed by her claiming zero, they would have withheld more tax from her paycheck, resulting in a refund.

More info:

  • No other taxable income besides our two full-time jobs. I run a single-member LLC, but take no income from it at all.
  • 2
    Just claiming no exemptions might not be enough; you might need to request withholding at the Single rate too, especially as you have self-employment income, on which you owe not just income tax but also Social Security and Medicare tax, both the employee's share as well as the employer's share. Did you by any chance put your self-employment income on the "Other Income" line instead of on Schedule C in your tax software program? – Dilip Sarwate Jan 10 '17 at 18:09
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    Owing $500 is almost the perfect situation. You don't owe any penalties, but got to hold onto $500 for some portion of a year. – Joe Jan 10 '17 at 19:09
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    @Moses At least you have 4 months' notice to save up that $500. Good job getting this done now. And, I'd doublecheck there aren't any other deductions/credits you can take advantage of - you never know what's out there. – Joe Jan 10 '17 at 19:12
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    So you own a ("legal entity" as you call it or) corporation (of which you are the sole employee?) but the corporation does not pay you any salary; it just keeps all the profits to expand etc. Does this corporation file its own income tax returns (and pay taxes at corporate rates)? Would it cost less overall if the corporation paid you a salary (thereby reducing its taxable income and corporate income tax due) and you paid income taxes on the salary? Or is the legal entity a DBA entity in which case you need to report the profits on Schedule C as self-employment income? – Dilip Sarwate Jan 11 '17 at 14:24
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    It is very relevant if you have an unincorporated sole proprietorship (DBA or Doing Business As entity) and are not reporting the profits on Schedule C. It is also relevant from your overall financial perspective if the sole proprietorship is incorporated in that the corporation that you own is worth less because of all the income tax (at corporate rates) it must pay, and your net worth (which includes the value of the corporation) might be larger if the corporation paid you a salary (which reduces its taxable income) and you paid income taxes at personal rates on that salary – Dilip Sarwate Jan 11 '17 at 14:47
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The W-4 functions best when there is a single earner with a single job. When there are multiple earners and/or multiple jobs per earner, it doesn't function quite as well (without additional withholdings). The employer, who is deducting taxes from your paycheck, is only aware of the pay that you are earning from them.

Consider the case where an individual makes $100k (after deductions) and their spouse makes $0. Using the 2015 tax brackets, that couple owes ~$11,400 in federal taxes.

Now consider the case where an individual makes $100k (after deductions) and their spouse makes $100k (after deductions). Using the 2015 tax brackets, that couple owes ~$37,200 in federal taxes.

The problem is now clear. If each earner is withholding $11,400, they will still be short over $14k. You're experienced something similar, just in a much smaller amount.

If you have self-employment income, then this gets complicated further. Your best bet is to find a calculator online that will take your anticipated salaries as inputs, and tell you how much additionally to withhold using your W-4.

  • 3
    +1, good explanation. The online calculator you are looking for is here on the IRS website. – Ben Miller Jan 10 '17 at 15:26
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    Just curious, can this be negated by filing separately? – Sidney Jan 10 '17 at 19:39
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    @Sidney Married-Filing Separately is almost always either equivalent (rarely) or far worse (commonly). Many exemptions, credits, and deductions have significantly lower upper limits. MFS is almost always only appropriate when divorcing. – Joe Jan 10 '17 at 22:30
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    @Mehrdad It's not illegal. I claim many more exemptions on my W-4 than I actually have on my 1040. If I didn't, my refund would be too big. See this answer for more explanation. – Ben Miller Jan 11 '17 at 2:13
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    @Mehrdad in fact when you use the online W4 calculator it tells you to adjust the withholding numbers to get the desired result. The info on that form are just input for a simple formula to calculate how much tax to withhold. If you get it wrong and significantly under withhold then the IRS penalizes you at tax time. – Eric Johnson Jan 11 '17 at 13:03
6

Don't use the guide on the W-4 itself to calculate your exemptions. It's often wildly inaccurate.

Instead, use a Payroll Deduction Calculator like this one. Adjust the number of exemptions until the witholding is more reasonable, based on last year's tax return numbers.

  • 1
    Or just use the one that the IRS itself hosts apps.irs.gov/app/withholdingcalculator – JamesCW Jan 11 '17 at 15:45
  • @JamesCW: It looks very detailed. It's probably accurate, though I didn't get through all of it. The payroll deduction calculator will get you there with much less information required (just an existing paycheck stub and your refund/owe amount from last year, assuming nothing radical has changed in your current return). It was the way I found out that I was claiming far too few exemptions (one for myself, one for my wife). – Robert Harvey Jan 11 '17 at 15:49
  • For me, it was reassuring to have it come straight from the IRS, especially as regards to the legality question in the comment thread on Derek's answer – JamesCW Jan 11 '17 at 15:57
3

What the accepted answer failed to explicitly mention is the root cause behind the phenomenon, which is twofold:

and

In essence, when your and your wife's salaries are combined, you enter a new, higher tax bracket. That means the additional amount above the last tax bracket is taxed at a higher percentage than either of your withholding charts would indicate.

  • @keshlam : Maybe it is just me, but the other answers don't seem to actually answer the OP's Q: "I claim one and my wife claimed zero on our W-4s, but we still owe…why?" This answer explains exactly why, but not how to fix it, which has already been covered. – MrWonderful Jan 11 '17 at 2:25
  • .... Point granted. – keshlam Jan 11 '17 at 2:36
  • The marriage penalty was "fixed" for couples in the lower brackets and slightly mitigated for the mid-level brackets, at least until 2013 when some of the "Bush tax cuts" expired. I don't recall if Congress extended the fixes after that. – Adrian McCarthy Jan 11 '17 at 21:15
  • @AdrianMcCarthy As of tax year 2016 (the one presumably being asked about,) the "marriage penalty" kicks in at just under $152,000 in combined income. If each spouse could file as single, they'd each be able to make up to $91,150 before the 28% rate kicked in. – reirab Jan 11 '17 at 21:47
  • Time to mention that you can't avoid some form of the marriage penalty in a progressive tax system. – Andrew Lazarus May 5 '18 at 0:12
0

Unless you can't estimate your 2017 income, there's just no reason not to do the math. Apparently you know how much you'll owe for 2016? Increase all amounts (or decrease) to reflect what you expect for 2017. Then work through the IRS W-4 calculator and compare what they estimate your taxes will be (say $14,000) and what you calculate they are (say $16,000). The difference should be divided by the number of paychecks you get each year (say 24) and put on line 6. If you really want a big refund (you lack the discipline to save regularly) then check the box on line 3 which allows married to be treated as single. The other obvious issue that needs to be addressed is: are you sure you're not making a mistake on your taxes? Unlikely with tax prep software, I grant you. You should also do two other things: 1. Take a look at your and spouses 1st 2017 pay stub, see how much they're now taking out and check again after your new withholding kicks in. Make sure it adds up to total you expect to owe (plus or minus) 2. Sometime this July, check again.

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