Do you get big tax refunds every year? Cut them out! This article will show you how.

In a following article, I offer to help you fill out your W4 and DE-4, or check your math, for free. (See details to follow; there’s no sales pitch, no obligation of any kind.)  

Also in a following article, I will share insider tips on how to correct over- or under-withholding; how to use paycheck withholding like a time machine to fix problems earlier in the year; and even how to shut down your withholding, if justified!

WHAT’S THE PROBLEM?

In my experience, most homeowners in Orange County, California withhold way too much in taxes. Some of us like getting a big tax refund. It’s a great way to avoid a big tax bill in April.  But I’d rather not let the IRS sit on my money all year.

If you consistently get large tax refunds, now’s the time to see if your withholding is too high.  A few minutes of effort might increase your cash flow all year long!

AM I WITHHOLDING TOO MUCH?

It’s super-easy to figure this out. Look at your most recent paycheck, and find the federal withholding for the “current period.” Multiply this figure by the number of paychecks left in the year. (You get 24 checks if paid twice monthly, and 26 checks if paid every two weeks.) Add the result to the “year to date” federal withholding figure shown on your paycheck. This is your projected withholding for the year.

Simply compare that projected withholding to last year’s “Total Tax,” shown on line 63 of your most recent Form 1040 (assuming this year will be similar to last year). It’s easy to see if you are likely to withhold way too much!

Since California also imposes significant income taxes, repeat this with your state tax withholding, too.

To refine this rough approximation, here are a few easy adjustments to make:

1. You have two jobs or your spouse works, too. This one’s easy. Since each job’s withholding is separate from any other withholding, just project each job’s withholding separately, and add them all up.
2. You get bonuses. If you will receive a bonus, paid in a separate paycheck, it will be subject to withholding at special flat rates of 25% federal and 10.3% California (for 2017). If you haven’t received your bonus yet, add 25% of the expected bonus to the regular paycheck withholding you computed above. These rates are far higher than the actual rate of tax many people pay, so bonuses can easily create excessive withholding. That money can be tied up for 15 months, until April of the following year!  Incentive pay that comes on the same paycheck as base pay is typically not withheld at these special rates.
3. Your taxes change a lot from year to year. I’ve suggested comparing your 2017 paystubs to your 2016 (or even 2015) tax return. This won’t make sense if your income or deductions will change significantly this year. Your WorthPointe advisor can help you determine whether asking your tax advisor to make a detailed projection might be worthwhile.
4. Tax laws change from year to year. If tax laws change, after a year of transition, these year-to-year comparisons will probably be valid again. Ask your advisor about any big changes in income, deductions or tax law.

HOW DO I FIX IT?

Withholding is easily changed using Form W4 (and in California, Form DE4). Most people claim zero, or a random number of allowances on this form, rather than plow into the worksheets. Many of us haven’t filed a new form since the day we were hired, and we didn’t exactly study it when faced with all the “new hire” paperwork.

It’s really pretty simple. The IRS assumes every dollar of salary will be taxed, and they withhold what they think you’ll owe. But they don’t know about your personal exemptions and itemized deductions. That’s what the forms tell them.

HOW MANY ALLOWANCES SHOULD I CLAIM?

Fastest Possible W4 Approximation: If you’re single, or the only spouse with a paycheck, just do this to get a rough estimate of the withholding “allowances” to claim on line 5 of the W4:

1. Add up your itemized deductions.

2. Subtract the standard deduction (here it is for 2017):

• $12,700 if married filing jointly or qualifying widower
• $6,350 if single or married filing separately
• $9,350 if head of household

3. If the result is zero or negative, stop here (and claim zero allowances); if positive, continue.

4. Divide by $4,050 (dropping any fraction from the result).

5. Add the number of people in the household (yourself, your spouse and your dependents).

It’s common to come up with a surprisingly large number. For example, let’s say you expect to deduct:

• $20,000 in mortgage interest (e.g., 4% interest on a $500,000 mortgage)
• $10,000 in property taxes (that’s an $800,000 valuation at 1.25%)
• $12,000 in California income taxes (look for “total tax” on line 64 of your CA Form 540, if last year is much like this year)
• $8,000 in charitable contributions

That adds up to $50,000 in deductions. If you’re married with two kids, subtract $12,700, divide by $4,050 and add 4 (for the number of people). You’ll get 13 allowances.

Since each allowance is worth $4,050, basically you’re telling the IRS not to withhold on $52,650 of your salary! If you make $150,000 to $200,000 per year, that’s a quarter to a third of your pay that will be exempt from withholding. This can make a big difference!

Getting an Exact Figure. My official advice is to complete all the worksheets on the W4. The worksheets add these steps, which are easy with a copy of last year’s tax return handy:

6. The itemized deductions in step 1 should be reduced to the extent you have other income on lines 8-21 of Form 1040, like interest, dividends, gains, rentals, self-employment, and alimony you received (or increased if this “income” is actually a loss).

7. Add to the itemized deductions any “adjustments” on lines 23-35 of Form 1040, like HSA contributions, specific self-employment items like health insurance and savings plans, alimony you paid to others, and certain student expenses, all of which reduce income.

8. Finally, the “number of people” in step 5 above should be increased by one if:

• You are single and have only one job
• You are married and only one of you gets a paycheck
• You are filing as head of household    

WHAT IF I AM MARRIED AND WE BOTH WORK?

Sorry, you have to do the “Two-Earner” worksheet on page 2 of the form.  The IRS knows one spouse’s income is taxed “on top of” the other’s, perhaps in higher tax brackets, so you have to do the math.  The good news is, you’re likely to be a higher-income family, with larger deductions, and so may benefit even more from taking the time to fill out the form.

Your WorthPointe financial advisor can make sure you and your tax advisor are on the same page regarding your income, deductions, cash flow, and withholding.  Working together, we can make sure you don’t have huge tax bills — or huge tax refunds — in April next year.

If you would like to brainstorm with us about any financial issues you are facing, please contact us here to start a conversation!

Now that you have some tricks up your sleeves to cut your tax withholding, please watch for my next post: Orange County Homeowners’ Guide to Justifying Low Withholding, where I’ll offer to do this for you! In the meantime, if you have questions, please don’t hesitate to reach out here.