Myth Busting - Withholdings, Refunds and Taxes

There’s a myth that working more one week and working less another week will affect your taxes. Some people try to regulate their hours week to week to keep their tax rate down. While this may affect your withholdings (the tax pre-payments that come out of your paycheck every week), but it does not affect the actual taxes you must pay.

 How does it work? A “Guess n’ Correct” system 

Your actual taxes are calculated based on your total yearly income, your deductions (either the standard deduction or itemized deductions), and things you did to earn credits (like save for retirement, have kids, or take the Earned Income Credit).

This is all based on the calendar year, so the clock starts on January 1 and ends on December 31.

Our tax system is pay-as-you-go: that is, the IRS likes to get its taxes when you make the money. The IRS has rules where employers must set aside a portion of the paycheck for taxes each pay period.

There’s no way your employer knows what credits and deductions you’re going to take, or even what your total income will be at the end of the year. So, they make a good guess. They make this guess based on what you write on your w-4.

The taxes that come out of your paycheck are an estimate. Witholdings = Tax Estimate. The IRS has specific rules that they make all employers use to estimate how much of each pay check to set aside for taxes. This is based on two things: what you wrote on your w-4, and how much you make each week.

Time to Square Up

Around April 15, when you file your taxes for the prior year, what you are really doing is squaring up with the IRS for the previous year. Based on the IRS’s rules about witholdings, if you have a particularly high earning pay period, the IRS withholds from you that week like you’ll make that weekly wage all year. This means withholding more taxes, because high earners are taxed at higher percentages.

But if you work a lot in one week and less in another, and it raises your tax withholding rate for that first check, it doesn’t mean your actual taxes went up. Remember, taxes are calculated on a yearly basis- that is, everything you earned between January 1 and December 31- so pushing money around between two weeks of the same year has no effect on your actual taxes. It may have some effect on your take home pay and refund, though.

Refunds Aren’t Free Money from the Government 

At the end of the year, when you get your w-2, you see the boxes for taxes withheld on boxes 2, 4, 6, 17 and 19: for Federal, Social Security, Medicare, State and Local. This is all the money that came out of your paycheck during the year! They’re payments you’ve already made to the IRS.

From these, you subtract the actual tax you owe from your Federal and State/Local income tax returns. So what happens if your employer overshot the guess, and set aside more than you really owe in taxes?

What is left over is sent back to you as a tax refund. 

Tax refunds are not free money- they are your overpayments being sent back to you. You can see how this works on your tax return paperwork. And of course, if you didn’t withhold enough, you will owe the IRS in March.

If you feel that you are withholding too much or too little, or had a life event such as marriage, divorce, birth or adoption of a child – let your employer know. You’ll need to fill out a new w-4.

Can’t I just withhold nothing then and get bigger paychecks?

Since we’ve got a pay-as-you-go system, the IRS has rules about minimum withholdings. You can read the rules straight from the IRS website here. If you’ll end up owing over $1000 of taxes, you must withhold. For most people, The total of your estimated taxes (taxes you send in) and your withholdings (what your employer sends in on your behalf) must be 90% of this year’s taxes or 100% of last years total tax due. (110% if you’re rich).

Learn more about taxes: Standard vs Itemized Deductions and the New Tax Bill

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