28

A thought crossed my mind recently and I was wondering if someone could explain if I'm missing something, and if so what.

Simply put, as an individual filing taxes (single, no dependents), taking the standard deduction, working the same job each year with the taxes taken out of each paycheck, shouldn't I have a zero tax balance when I complete my 1040 ?

This stems from the (possibly incorrect) assumption that my work is withdrawing taxes from each paycheck correctly. If that is true, shouldn't I be all paid up at the end for the year?

I was discussing this with a friend recently, and we couldn't see the flaw, but I am sure I am missing something because, frankly, it sounds too good to be true.

So if a single person takes the standard deduction for their US taxes, works the same job all year, has no tax credits/penalties, but somehow still get a refund or owes additional taxes, does that necessarily mean that their paychecks were off? Or is there something else I am missing?

  • 15
    Withholding calculations are woefully inadequate and typically lead to very large returns, or owing money. – Pete B. Jan 12 '18 at 11:33
  • Because your employer doesn't use Turbo Tax to calculate how much to withhold for each paycheck. – BlackThorn Jan 12 '18 at 17:14
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    I'm not sure if these merit a separate answer, but two further issues are: If you don't have your job for the whole year, that throws the calculations off. Also, if you want the witholdings to be correct down to the penny, then rounding is going to be an issue; round(a)+round(b) can easily be different from round(a+b). – Acccumulation Jan 12 '18 at 18:06
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    @Acccumulation actually, due to IRS rounding, you don't need your withholding to be accurate down to the penny, just to 0.50. – iheanyi Jan 12 '18 at 19:44
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    Anecdotally, the first year I started working, I owed $1 to state and got a $1 Federal refund. But that year I was not head of household, had no deductions, no credits, no interest, was single, and had work hours I could predict down to the minute. Every year since, I've received a refund using just standard allowances. There's so many rules regarding taxes that owing close to $0 is practically a once-in-a-lifetime event. – phyrfox Jan 12 '18 at 20:02
39

The withholding is not that accurate. Look at the personal allowances worksheet (PDF). A single allowance could be

  1. You, filing.
  2. You, filing married; spouse not working.
  3. You, filing Head of Household.
  4. A dependent.
  5. $2000 or more of creditable dependent expenses.
  6. A child, if you make less than $70k and have 2-4 children.
  7. Half a child, if you make less than $70k and have one child.
  8. A child, if you make $70-84k.

But these events are not all the same. For example, you filing singly was about a $6k deduction. And you filing as your own dependent was about a $4k deduction. However, for withholding purposes, they treat them identically. They don't even know what your 2 allowances mean. They just know that you wrote a 2 there.

Note: the new tax law will change these numbers but is unlikely to change the basic problem.

So no, even if you fill out your withholding correctly, only have one job, have the same compensation for the entire year (no overtime or raise to confuse things), don't itemize or have nonstandard deductions, and are single, you are not guaranteed to have the correct amount withheld from your paycheck even if your employer follows your filing.

Of course, if you do itemize or have nonstandard deductions, a second job, or varying compensation, this can be even worse.

  • According to OP, "an individual filing taxes (single, no dependents), taking the standard deduction, working the same job each year". Thus, 89% of your allowances are meaningless. – RonJohn Jan 12 '18 at 14:59
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    @RonJohn - true, but harsh. Brythan's answer offered a bigger picture of the issues the (typical) single digit output the W4 creates. When another member has a similar question, but whose exact situation is slightly different reads this, they'll see an answer that covers them as well. – JoeTaxpayer Jan 12 '18 at 15:17
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    And I think you both are missing the point. The withholding is based on the allowances. Even if head of household is not the withholding that this person uses, the system still relies on every one of these situations being identical. So when this person files as single, standard deduction, no dependents, the system can't tell the difference from any other situation that produces two allowances. E.g. the second job of a head of household with three dependents who already claimed three or more allowances on the first job. – Brythan Jan 12 '18 at 19:50
21

This stems from the (possibly incorrect) assumption that my work is withdrawing taxes from each paycheck correctly.

I think this stems rather from an ambiguity in the use of the word "correctly". I would expect that your employer withholds correctly in that it complies with the Internal Revenue code, and particularly the regulations for calculating and withholding taxes published annually in IRS Publication 15.

What your employer is not doing is calculating your end-of-year effective tax rate, and then applying that rate to each paycheck. That is not possible to do in the general case.

The information your payroll department has from your W4 form is only your marital status and the number of allowances that you claim. Even if you know that you have no dependents, no investments, no interest-bearing savings, and no other jobs, none of that information is available to payroll (except informally, if you work for a small employer). And as Brythan points out, an allowance can mean any number of things, with different tax implications alone or when combined.

If you want your withholding to be closer to your exact per-check tax liability than the approximation given by your number of allowances, you can fine-tune the withholding amount by filling in a dollar amount on line 6 of your W4, rather than relying on the allowance count alone.

  • 5
    put more clearly: The tax withholds are a back-of-the-envelope-estimation, so that at the end of the year the amount you owe is probably small. This is important so people don't have to save up as much, and the gov't can spend the money sooner. – Mooing Duck Jan 12 '18 at 21:03
  • I would assume in my case the effective tax rate is fairly consistent through the year for my job. I am salaried, work in a small company (~20 people), we typically get a Christmas/holiday bonus (with taxes taken withdrawn) and one raise a year that takes effect usually in the first month. Not a lot of variation throughout the year otherwise, but I could see how that could cause some estimation errors. – PawnInGameOfLife Jan 13 '18 at 2:29
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    Note that end of year bonus can cause problems. If it a lump sum many companies follow IRS guidance and withhold 25%, or they add it to the regular paycheck and that one check looks like you make a lot of money which can mean that it is withheld at too high of a rate for that one check. You will get the extra back in April, but that does throw off the withholding. – mhoran_psprep Jan 13 '18 at 12:22
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    @Qsigma, this answer is all in context of the US tax code, so "not possible in the general case" is comparing other US tax payers with this particular US tax payer, not comparing the US income tax system with other tax systems. Even in the US, the federal social insurance taxes (as opposed to the federal income taxes) are withhold on an exact pay-as-you-go basis, with end-of-year adjustments never needed for wage-earners with a single employer, covering most US taxpayers. Note the W4 is not the cause of the complication; it is a symptom. – user4556274 Jan 14 '18 at 13:53
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    @MooingDuck "amount you owe is probably small". I suspect the IRS sets the withholding rates to usually overwithhold, so people are more likely to get a refund. This allows the government to take advantage of the float. And naive taxpayers like to get refunds, they think of it as a bonus. – Barmar Jan 15 '18 at 8:53
12

Two things I can think of:

  1. You might have changes to your AGI that the payroll system doesn't know about. Extra income like dividends or a side job, for example.
  2. You filled out your W-4 incorrectly, or haven't updated it lately.
  3. As @JPhi1618 mentioned, overtime pay will throw a wrench in the calculations.

EDIT: this is based on OP's qualifications:

  1. an individual filing taxes
  2. single, no dependents
  3. taking the standard deduction,
  4. working the same job each year
  • 3
    3) Unemployment. 4) Change of employment. I was employed for 4 months... unemployed for 4 months... then got a new job which pays 20% more than the first 4 months. So the last 4 months are taken out at a higher bracket. At the end of the year, the new job at a higher bracket will get adjusted down - since that higher tax rate assumes I'll make X for the year but in reality, for the year, I made much less than X and will get taxed for Y. – WernerCD Jan 12 '18 at 14:45
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    5) Change of tax laws. – Simon Richter Jan 12 '18 at 16:36
  • @SimonRichter I think that's covered under "#2 You filled out your W-4 incorrectly, or haven't updated it lately." – RonJohn Jan 12 '18 at 17:13
8

If you work an hourly job with even a slight variation of hours per week, withholding calculations tend to be less accurate. The payroll system doesn't know what your final income for the year will be. Lets say that one week you get super busy and have 10 hours of overtime. Some payroll systems will calculate withholding on that large check as if that's how much you will get paid every week, so you would be paying taxes as if you made 50k a year rather than the 40k you actually make (random example amounts). Imagine you get sick and only work 24 hours one week - same thing - taxes will be deducted as if you were below the poverty line.

With a fixed salary job, the system knows exactly how much you will get paid at the end if the year, but even then things can go wrong if you get a raise mid-year, or a bonus, or you cash in vacation days, etc.

The other answers are also correct, but even if the payroll system knew exactly how you would file your taxes with all deductions, the simple fact is, the system really doesn't know how much money you're going to make.

  • Good point regarding overtime. – RonJohn Jan 12 '18 at 15:02
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    "Some payroll systems will calculate withholding on that large check as if that's how much you will get paid every week" The word "some" looks off here. Do you know of a payroll system in use in the United States that does not implement the calculations described in IRS Publication 15? – user662852 Jan 12 '18 at 15:04
  • @user662852, It was a long time ago, but I did work on QuickBooks which did payroll calculations like I describe. I honestly don't know what that publication says and what QuickBooks does now, so I hedged with "some"... There are a lot of small businesses out there that don't use some giant payroll processor that adheres to the letter of all the tax codes. – JPhi1618 Jan 12 '18 at 15:10
  • @user662852, looked over "Publication 15" a little, and it seems to specify that you should calculate withholding based only on the amount of the current pay period, which is exactly what I described. So maybe you are saying that "Some" should be "All"? I guess I'm not sure what you're getting at now. – JPhi1618 Jan 12 '18 at 15:17
  • Yea I did mean to mention I work a salary job, but perhaps it is better that I didn't so that this explanation for hourly work (thanks for covering that). – PawnInGameOfLife Jan 13 '18 at 2:24
4

Since a "Withholding Allowance" is equivalent to the now-cancelled exemption ($4000), the granularity was never very fine to start. The W4 offered a box to withhold additional dollars. You can add an allowance, and if that would have you underpay a bit, just add that many dollars to the additional line. You can easily adjust the withholding to within a few dollars of the correct number, if that's your goal.

3

The IRS is planning to release a new form W-4 and withholding calculator in February of this year. They are not recommending that everyone fill out a new W-4 until 2019 at which time they expect to have a bigger revamp that will lead to more accurate withholding. (Though, obviously, new employees should use the new form W-4 when it arrives.)

It's probably wise to wait at least until the new form arrives before making changes, but yes, hopefully these changes will allow everyone to set withholding levels more accurately.

  • Great to know!!! I did not realize this was in the works. – PawnInGameOfLife Jan 13 '18 at 2:25
2

Yes, the paychecks are "off", but the reason is because the tax code is so complex that even if the calculations were exact it probably wouldn't apply to many people. Even in your case, if you gained just $5 in interest that year your overall tax liability changes. Your employer won't know about this and can't factor it into the calculation. Once you have a dependent the numbers change wildly because exemptions on a W-4 have different values depending on their type.

That being said, the premise of your question is a good one. It should theoretically be possible for the IRS to add a checkbox on the W-4 called "Single, no other income, no deductions." If checked, a specific algorithm could be used for your payroll that could zero out at the end of the year. Of course, I don't think that would ever happen as very few people could (or would) check it.

-1

Let us assume for a moment that you get a tax refund of X dollars and that your employer magically got everything right on their end.

You didn't get a tax refund because the government overcharged you. While I do not know the exact details there is another way to get a tax refund. Because the government of some states is nonprofit a thing I have noticed is that if they have a tax surplus at the end of the year, they put in everyone's tax refund. It is basically the government saying "you get a discount this year because we didn't need all of your money".

Note: I dont know the legalese behind this. It is merely something I have observed.

  • The tax surplus checks are one-time events that are not directly related to income tax. This doesn’t really address the OP’s question. – Ben Miller Jan 13 '18 at 21:31
  • @BenMiller "So if a single person takes the standard deduction for their US taxes, works the same job all year, has no tax credits/penalties, but somehow still get a refund or owes additional taxes, does that necessarily mean that their paychecks were off? Or is there something else I am missing?". The tax surplus is a tax refund. Where does the OP say it must be "directly related to income tax"? – The Great Duck Jan 13 '18 at 22:49
  • The last time the federal government sent out the surplus/stimulus payments was in 2008. I think it’s safe to assume that the OP isn’t asking about that now. – Ben Miller Jan 13 '18 at 23:36
  • @BenMiller Reread my post. I said state governments. – The Great Duck Jan 13 '18 at 23:37
-3

The IRS calculates your tax at the end of the year, with complete knowledge of all the facts, and (hopefully) they are really competent and always get their numbers right. Your company is much less experienced at calculating taxes, so they will make mistakes. They have the huge disadvantage that they have to do the calculation every month with no knowledge of the future, so they don't know about future unemployment, pay rises, varying overtime, bonuses, deductions that you gain or lose through the year. They don't even know precisely what deductions you have today. So the numbers will often not match up.

In the end, you don't lose or win any money, it's just a bit delayed.

  • 1
    -1. The discrepancy is not due to mistakes in calculation from inexperience by the employer. It is due to the fact the fact that it is impossible for the employer to know what the taxes will be at the end of the year, as the other answers have all pointed out. – Ben Miller Jan 13 '18 at 12:19

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