How to Calculate Proper Paycheck Withholding

In this month’s video, I explained a couple of the goals when we complete a tax projection for clients.  For some taxpayers, a tax projection can have many moving parts making the assistance of a tax advisor essential.  For others, this process can be completed without outside help.  The main category of people that this would apply for is those with W-2 jobs.  To help those folks out, here is a step-by-step guide to calculating whether you have the proper paycheck withholding.  This is a good basic plan for anyone and can be tweaked for more complicated circumstances.

Step 1: Calculate your annual earnings.  You can use your salary minus any pre-tax items such as your 401(k), health insurance, or FSA contributions.  If you ever have items outside of your salary, such as bonuses or taxable stipends, it will work best to pull your year-to-date income from your most recent paystub.  Then add to it your payment per paycheck times the number of paychecks left during the year.

Step 2: Calculate your anticipated withholding.  From your most recent paystub, take the amount of Federal withholding.  You will add the year-to-date amount to the current check amount times the number of paychecks left during the year.

Step 3: Add other sources of income or subtract any adjustments from income.  This would include adding in your interest or rental property income.  You would subtract things like your out-of-pocket HSA contribution.  Combine these items with your annual earnings from Step 1 to get your Adjusted Gross Income.

Step 4: Estimate your standard or itemized deductions.  Total your expected deductions including charitable donations, home mortgage interest, and state and local taxes (capped at $10,000).  Then compare that to the standard deduction for your filing status.  Keep in mind the standard deductions are higher for 2018, and there are no longer personal exemptions.

Step 5: Calculate your taxable income.  Subtract the result from Step 4 from your total in Step 3.  This is the amount that you will calculate your income tax on.

Step 6: Calculate your income tax for the year.  Use the result from Step 5 to calculate your tax with the appropriate table.

Step 7: Compare your calculated tax against your anticipated withholding.  Compare the numbers from Step 2 to Step 6.  If your withholding is more, then expect a refund when you file.  If your tax liability is more, then you will owe additional money.  You may need to update your W4 with your employer to avoid penalties.

If all of these steps seem like too much trouble, the IRS does have a withholding calculator that you can try.  With the changes under the Tax Cuts and Jobs Act, a double check of your withholdings in 2018 is more important than in years prior.

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