How do you figure out your W4 withholding?

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Raladic
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How do you figure out your W4 withholding?

Post by Raladic »

Hi,

I was inspired by this thread How much was your Tax Refund (or amount DUE) to understand howyou figure out your W4 withholding.

Based on some of the responses on the above thread, some people are amazingly close to 0 when it comes to tax return time so I'm trying to understand how you get to predict your liability-to-withholding so closely.

I understand there's the IRS withholding calculator (http://www.irs.gov/Individuals/IRS-With ... Calculator), but with multiple incomes, variable bonuses and unknown raises until further into the year, is there any magic secrets to a best guess of the withholding I'm missing?

Thanks,
Raladic
Spirit Rider
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Re: How do you figure out your W4 withholding?

Post by Spirit Rider »

First, people who are close to $0 are more likely lucky, than planned. This is because the common way to adjust withholding is by increasing or decreasing exemptions. The exemption for 2015 is $4000, which if you are in the a 25% marginal tax bracket, will increase or decrease your withholding by $1000 for each exemption change.

One way to deal with this is to not "set and forget" your withholding for the whole year. Review your taxable income, deductions, and withholding to date and adjust exemptions as needed. I do a review quarterly, 1/1, 4/1, 7/1, and 10/1. Also, you should review this anytime your circumstances significantly change (raise, bonus, pretax retirement withdrawal, capital gains , etc...)

If you really want to fine tune, you can use the W4 and specify a specific additional dollar amount per pay period.
livesoft
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Re: How do you figure out your W4 withholding?

Post by livesoft »

Here is essentially what I do: I look at my last year's tax return. I see my tax liability, so call that T. I know I get 26 paychecks a year, so I have $T/26 withheld from every paycheck.

OK, the reality is that in the early months of the year, I get no income since I have most of my paycheck go to the 401(k) plan (I frontload my contributions), so I have no income tax withheld. Once that is over, then I do the $T/NP where NP is the number of paychecks left.

Then you can ask, "How can one convert a dollar amount to a W-4 form?" So I walk into my HR/Payroll office and I say, "What do I put on my W-4 so that I have $T/NP withheld every paycheck?" They look it up in less than a minute and tell me, so I fill out the W-4 right then and turn it in.

Then on Thanksgiving week, I do a pro forma tax return and see where I stand. If I need to change my withholding for my December paychecks, I do so … once again I walk into my HR/payroll office and my friends fix me up.
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Toons
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Re: How do you figure out your W4 withholding?

Post by Toons »

"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
kaneohe
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Re: How do you figure out your W4 withholding?

Post by kaneohe »

[quote="Raladic"................................................... so I'm trying to understand how you get to predict your liability-to-withholding so closely.
Raladic[/quote]

First as you stated there are 2 pcs to the puzzle. Liability (Tax for the yr) and withholding. For the liability, you have to do as livesoft says and calculate your predicted tax for the yr (which may change along the yr). Then you have to manage your withholding to match the liability. The way I liked was to under-withhold using the basic W4 form
and then to add an additional amount per pay period as Spirit Rider suggests (the W4 allows for that). You can figure out that additional amount from the actual vs desired withholding to date. That puts things entirely within your control vs assuming you/someone else knows what will happen by changing exemptions. You will will have to monitor along the way to make sure things are on target.
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grabiner
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Re: How do you figure out your W4 withholding?

Post by grabiner »

I fill out the IRS worksheets, including the instructions for adjustment for qualified dividends and tax credits. This actually works pretty well for a single taxpayer; I usually wind up with a small tax bill, or occasionally a small refund, depending on how well my estimates reflect what happens later in the year.

I have only twice gotten a large refund, and both were unavoidable. One year, I made a large charitable contribution in December, and couldn't adjust my withholding accordingly. Another year, I had a small tax due on April 15, then amended my return to recharacterize an IRA contribution and got a big refund on the amended return.
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Aptenodytes
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Re: How do you figure out your W4 withholding?

Post by Aptenodytes »

I do mostly what Livesoft does, except my employer lets me adjust the federal withholding online and I rely on trial and error to get the right level. I adjust once or twice during the year.
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grabiner
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Re: How do you figure out your W4 withholding?

Post by grabiner »

Aptenodytes wrote:I do mostly what Livesoft does, except my employer lets me adjust the federal withholding online and I rely on trial and error to get the right level. I adjust once or twice during the year.
I have adjusted mid-year when my situation changed. When I made a large charitable contribution early in the year, I added withholding allowances to avoid getting a big refund. When I converted a traditional IRA to a Roth IRA, I increased my withholding to avoid owing a penalty and claim a legally allowed number of allowances; on my state return, I actually had to add extra withholding beyond zero allowances in order to meet the state's minimum withholding.
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aquifer
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Re: How do you figure out your W4 withholding?

Post by aquifer »

http://www.taxvisor.com/taxes/index.html

I use my pay stub to extrapolate how much will be withheld by year end, and plug the numbers into the spreadsheet. I adjust my withholding accordingly. Works pretty well.
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House Blend
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Re: How do you figure out your W4 withholding?

Post by House Blend »

I keep a running estimate of my annual tax bill, and update it periodically as new information arrives. (All done in software, so I just insert the new numbers, and rerun the code.) The safe harbor approach also works, but I prefer to target a tax bill in the low hundreds. Typical year to year variation in my tax bills is much higher than that.

Once I have a targeted dollar amount I want withheld (subject to adjustment later with additional W-4 filings), I go to straight to the IRS rules to figure out how many allowances to claim and how much extra to withhold. The long story is Pub. 915, but there's a very short bulletin ("Notice 1036") that contains all the information I need:
http://www.irs.gov/pub/irs-pdf/n1036.pdf

Example:
Suppose you are filing Single and paid every two weeks.
Start with your gross wages for that pay period.
Subtract off all pre-tax deductions (401k, health insurance,...).
Suppose the net is $2500.

Suppose you claim 2 allowances.
According to the chart on p. 1, one subtracts $153.80 per allowance.
That's a net of $2500 - 2 x $153.80 = $2192.40.

From Table 2(a) on p. 3, that means your employer should withhold

$214.80 + 25% of ( $2192.40 - $1529 ) = $380.65

from your paycheck.

As a sanity check, try this with your latest paystub. If the results aren't close, either your employer is not using the "percentage method", or there is some other misunderstanding about what counts as (Federal) taxable wages, or what's on your W-4.
ryman554
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Re: How do you figure out your W4 withholding?

Post by ryman554 »

All of this stuff seems to complicated to my meager mind.

Assuming W2 worker..... and also assuming that your HR department gets your withholding right for your salary / deduction mix.

The big things are state income taxes and mortgage interest and property taxes, each of which you can estimate easily. That income comes "off the top", so
1. estimate yearly state taxes (last year or salary*rate),
2. mortgage interest (12*last months interest amount)
3. and property taxes (take last years).
4. If you have a charity budget, add that in, too.
5. Subtract out the the standard deduction. (use last years)
6. Divide by exemption amount. (use last years)
7. Fill out W4 form with the # of exemptions needed to change withholding. Choose to round up or down to determine whether you want to owe a little or get a little back.

Presto. Close enough. Takes 10 minutes to do.

Next year, when you get your refund / amount owed (or better yet, estimate in December!)

1. Divide your refund / tax owed by your tax rate.
2. Divide that by the exemption amount.

That tells you how much you need to change. By year 2 you should be pretty close.
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Aptenodytes
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Re: How do you figure out your W4 withholding?

Post by Aptenodytes »

ryman554 wrote:All of this stuff seems to complicated to my meager mind.

Assuming W2 worker..... and also assuming that your HR department gets your withholding right for your salary / deduction mix.

The big things are state income taxes and mortgage interest and property taxes, each of which you can estimate easily. That income comes "off the top", so
1. estimate yearly state taxes (last year or salary*rate),
2. mortgage interest (12*last months interest amount)
3. and property taxes (take last years).
4. If you have a charity budget, add that in, too.
5. Subtract out the the standard deduction. (use last years)
6. Divide by exemption amount. (use last years)
7. Fill out W4 form with the # of exemptions needed to change withholding. Choose to round up or down to determine whether you want to owe a little or get a little back.

Presto. Close enough. Takes 10 minutes to do.

Next year, when you get your refund / amount owed (or better yet, estimate in December!)

1. Divide your refund / tax owed by your tax rate.
2. Divide that by the exemption amount.

That tells you how much you need to change. By year 2 you should be pretty close.
Different strokes for different peeps. Your way makes my head hurt and has non-zero possibility of costly error. My way is far easier for me and guarantees no error.
vrr106
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Re: How do you figure out your W4 withholding?

Post by vrr106 »

if you're tax situation is not overly complicated from a deduction standpoint, I would run a withholding estimator 3-4 times a year and adjust withholdings to be as close to zero as possible. I just use the IRS calculator: http://www.irs.gov/Individuals/IRS-With ... Calculator
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Meg77
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Re: How do you figure out your W4 withholding?

Post by Meg77 »

It is much harder for me to estimate now that I'm married and have double the amount of income streams to guesstimate. I keep a "taxes" chart in Excel with my net worth statement and cash flow projection that is a simple version of the 1040 tax statement (which calculates your AGI and total tax owed). It looks like this:

gross wages
401k, HSA contributions
capital gain/loss
taxable interest
dividends/other income
Total Income/ AGI / MAGI

Personal Exemption
property taxes
mortgage interest
Sales Tax/state income tax deduction
charitable contributions
Total Deductions

Taxable Income
Net Investment Income
Income over $250K
Wages over $250K

3.8% surcharge
0.9% surcharge

TOTAL TAX OWED

Since we *plan* to earn X and max out retirement accounts, I can guess our gross wages pretty well enough. I always assume no capital gains or losses, a set charitable deduction amount, etc., and I update those cells throughout the year if there are major changes. Interest and dividends I take from the previous year as they don't change much.

The "total tax owed" cell is calculated based on a formula of the tax brackets I wrote which looks like this for 2015:
=(18450*0.1)+((74900-18450)*0.15)+((151200-74900)*0.25)+((H17-151200)*0.28)+H22+H23)
In this formula H17 is my Taxable Income (total income less total deductions), H22 is any 3.8% surcharge (which is owed on total income over $250K) and H23 is any 0.9% surcharge (charged on any wages over $250K). I may be off on my surcharge calculations, which I need to double check.

So periodically I compare the total tax owed projection with how much has been withheld from our paychecks. If it's way off around midyear we might fill out new W4s to adjust. But this is my first year being married so it's hard to say how much adjusting we'll need to do, because I'm not sure what the overall impact will be for each added exemption. We may have to do a trial and error.
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House Blend
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Re: How do you figure out your W4 withholding?

Post by House Blend »

ryman554 wrote:Assuming W2 worker.....
I think that's the issue right there.

I agree that if most of your income is a result of W-2 wages, and nothing unusual happens over the course of the year, then almost any system you come up with is going to work and not take up more than the 10 minutes required to adjust your allowances and extra withholding.

I think a majority of us who are describing what appear to be elaborate systems are in a different boat: multiple streams of income, variable amounts of self-employment income on the side, unexpected deductions, or other changes (new job, marriage/divorce,...).

In 2014, about 35% of my Taxable Income came from sources other than my (main) job, and could only be estimated at this time last year. Likewise, I have some decisions to make about 2015 that are keeping large error bars around my estimated taxable income until they are resolved.
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Aptenodytes
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Re: How do you figure out your W4 withholding?

Post by Aptenodytes »

House Blend wrote:
ryman554 wrote:Assuming W2 worker.....
I think that's the issue right there.

I agree that if most of your income is a result of W-2 wages, and nothing unusual happens over the course of the year, then almost any system you come up with is going to work and not take up more than the 10 minutes required to adjust your allowances and extra withholding.

I think a majority of us who are describing what appear to be elaborate systems are in a different boat: multiple streams of income, variable amounts of self-employment income on the side, unexpected deductions, or other changes (new job, marriage/divorce,...).

In 2014, about 35% of my Taxable Income came from sources other than my (main) job, and could only be estimated at this time last year. Likewise, I have some decisions to make about 2015 that are keeping large error bars around my estimated taxable income until they are resolved.
What livesoft and I do covers that circumstance and is very easy.
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House Blend
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Re: How do you figure out your W4 withholding?

Post by House Blend »

^Yes, a safe harbor approach is certainly simple, if you don't mind overpaying in some years.

With the Feds it is less of an issue to overpay (do a credit forward), but an itemizer who overpays the State will push next year's Federal AGI higher than necessary, which in turn can trigger credit/deduction phaseouts to ill effect.

My Federal income tax in 2011 was approximately 10 times larger than it was in 2012. Using a safe harbor approach based on the previous year would not have worked out well.

As I said in my first post in this thread, I don't rely on safe harbors, as I prefer not to overpay. I too end up filing zero, one, or (rarely) two W-4s (online) with my employer each year.

In any case, safe harbors are a cop-out that don't address the OP's question about how some Bogleheads are able to accurately estimate their annual tax liability and how they get the desired outcome from their W-4's.
bslice
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Re: How do you figure out your W4 withholding?

Post by bslice »

I use the TaxCaster app from TurboTax to help me estimate.
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Raladic
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Re: How do you figure out your W4 withholding?

Post by Raladic »

Thanks for all the responses, very insightful.

As a few folks on the thread have called out, yes with one single W2 income it would be simple, but with multiple incomes and the different things like raises, bonuses which are unknown until they happen, I just didn't see how one could just have a "one size fits it all" solution.

I'll take a mixed approach and try to estimate our expected taxable income and then re-calculate later in the year after actual numbers for the year become clearer and will re-adjust accordingly.

Thanks,
Raladic
Bill M
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Re: How do you figure out your W4 withholding?

Post by Bill M »

There is a field on the W4 for "additional withholding", which is added to the calculation based on marital status and exemptions. It is easy to adjust, and has a direct (and easily calculatable effect) on the paycheck.

Beyond that, the key is to check frequently, and adjust frequently.

Now that I'm retired, and doing quarterly estimated tax payments, it is both easier and harder. Much easier to adjust the amount I pay. But I don't get the "smoothing" from the W4 withholding. I tend to overestimate the early payments, and scale back the later quarters.
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grabiner
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Re: How do you figure out your W4 withholding?

Post by grabiner »

grabiner wrote:I fill out the IRS worksheets, including the instructions for adjustment for qualified dividends and tax credits. This actually works pretty well for a single taxpayer; I usually wind up with a small tax bill, or occasionally a small refund, depending on how well my estimates reflect what happens later in the year.
Note that the state worksheets aren't as good; you need to estimate your withholding with knowledge of the state tax forms. MD, for example, asks you to estimate your deductions but not your non-withheld income. Therefore, if you have a lot of investment income, or bonuses on which your employer did not withhold MD tax, the form will tell you to claim too many allowances.
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motorcyclesarecool
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Re: How do you figure out your W4 withholding?

Post by motorcyclesarecool »

I was running a scenario on the IRS withholding calculator, but couldn't figure out where to enter a LTCG. How does taxcaster handle w2 plus big LTCG?
Understand that choosing an HDHP is very much a "red pill" approach. Most would rather pay higher premiums for a $20 copay per visit. They will think you weird for choosing an HSA.
Wakefield1
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Re: How do you figure out your W4 withholding?

Post by Wakefield1 »

I believe that some States are harder on you if you were under withheld (had to pay too much State tax per the tax return)as compared to being under withheld on the IRS 1040 (just a little penalty?)
would rather not have that unpleasantness
motorcyclesarecool
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Re: How do you figure out your W4 withholding?

Post by motorcyclesarecool »

Perhaps I can clarify my question: is there a good withholding calculator out there that accounts for 401(k), HSA deductions, as well as salary and a sizable long term capital gain? The IRS tool does not appear to handle LTCG well.
Understand that choosing an HDHP is very much a "red pill" approach. Most would rather pay higher premiums for a $20 copay per visit. They will think you weird for choosing an HSA.
btenny
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Re: How do you figure out your W4 withholding?

Post by btenny »

The W4 tools just miss from my experience. So I always just used my 4 allowed deductions, 2 for me and my wife and 2 kids every year. This ended up with less actual federal deductions than needed for most years and less state than needed as well. The IRS did not like this. So after a while I just did a trial income tax guesstimate in November every year. I used our real work earnings and real stock market gains/losses and actual real estate income. It was a PIA and took several hours each year but produced a pretty accurate tax forecast. Then I went to work and did one time tax deduction on a special W4 for December to bring my taxes paid up to about what I would owe. This worked great for me for years. No penalties and no big overpayments.

In my case when I did not do this the first few years the IRS wanted me to do quarterly taxes. That was worse than what I did. Plus my method was more accurate.

Good Luck.
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