Who: This post is for people who enjoyed Part I and Part II of the Tax Basics. This post will be helpful for those who claim a lot of exemptions on their taxes, are working only part of the year, or for those crazy cats that want to get their tax refund over the course of the year, instead of at the middle of the following year.
What: This post will explain how to get all the money you are entitled to (tax refund) during the course of the year so you don’t have to wait for the IRS to give you one lump sum tax refund.

Disclaimer: I am not a tax accountant and only base my suggestions on my own readings and understandings of the tax laws. Follow the suggestions at your own risk, as I offer no warranty explicit or implied. You should always do your own homework before you read what some maniac writes on a blog on the Internet.


Some people are more excited about their tax refund than they actually should be. Let’s say you owed me $2000 and you lent me $5000 dollars in January and then in the following June, I gave you back the $3000 I owed you. Would you jump up and down screaming “I just got $3000!!!”? No, because it’s YOUR money that you’re getting back. That’s why it’s called a tax refund.

I find that this tip is very helpful for the students who don’t have much annual income because they only work part time jobs during the course of the year, or only during the summer. It also works pretty well for many of you that have a bunch of exemptions or have unsteady income over the course of the year. Don’t you just hate it when you only get 60 or 70% of your paycheck because of taxes? What about those fat bonus checks that are eaten by Uncle Sam, only to be returned to you months later?



If you want a general overview of taxes, I strongly recommend reading Part I of the series before continuing with this tip. Basically, on every paycheck, some pay is withheld from you and given over to the government. If you earn paychecks of the same amount consistently throughout the course of the year, then in theory you should have paid the correct amount of taxes, and you will neither owe tax nor receive a refund. However, most of the time, this is not the case for various reasons. A big bonus, having a lot of exemptions, or having unsteady paychecks (summer jobs) can all lead to withholding being incorrect. For a good example of how exemptions work, check out Part II of Uncle Sam’s Revenge.

Remember that having money NOW is better than having the same amount of money later (The Time Value of Money). With that being said, wouldn’t you like to receive your tax refund money over the course of the year rather than wait a year and a half for Uncle Sam to mail you a check? Yeah, that is exactly what I thought. “So, William, how do I do this?” I am glad you asked.

Step 1: Calculate the taxes that you will owe at the end of the year. If you already have a way to do this, good for you! If you’re not ahead of the game, you should read Uncle Sam’s Revenge Part 1 to figure out how to do this :-) I have linked to the article twice already, so I shall spare you a third link. Once calculated, this will be taxes owed. Remember to include all of your exemptions, deductions, and credits so you have a *good* estimate of how much you will owe.

Step 2: Take a look at your pay stub to figure out how much is being withheld from your paycheck for federal taxes. If you want some details of how to do this, check out Uncle Sam’s Revenge Part 2. Once you know how much is being withheld each pay period, do a calculation (including possible bonuses you may earn, etc) to figure out how much will be withheld over the course of the year! If your withholding is a bit more complicated to calculate, you can use this handy-dandy PayCheck Calculator from PaycheckCity.com. The total that is withheld will be called taxes paid.

Step 3: Most of the time, you will see that if you claim 0 or 1 allowances on your W-4 (as most people do, to be “safe”), you will have a very large tax refund. Tax refund = taxes paid - taxes owed. Why would you want to wait months to receive this money in a lump sum, when you could have it over the course of the year?

Step 4: How do you calculate how many allowances to put on your W-4? The basic process is to treat each allowance as an exemption. If you put 5 allowances, that means that the amount withheld, *in theory* will be correct if you end up claiming 5 exemptions. If you want to be lazy or double check your work, you can use another handy-dandy calculator from our friend IRS: Withholding Calculator.

That’s it! Once you have entered the correct number of allowances on your W-4, you’re done! This entire process will, in effect, reduce the amount of taxes you pay over the course of the year and decrease the amount you receive as a refund. In essence, think of this as a constant tax refund being given out to you over the course of the year instead of at the middle of the following year!

CAUTION!
CAUTION!
CAUTION!

1. Please refer to the disclaimer at the top of this page.

2. It is *very* important to keep in mind that you do *not* want to owe the IRS a lot of money at the end of the year. Going overboard or miscalculating the allowances that you can claim will cause some problems. As a general rule, if you owe the IRS more than $1000, you will be subject to interest charges since you have not kept up to date on your payments to them. This is a very generous cushion, but be very careful not to push your limits too much.

3. Financial situations changes from day to day and month to month. Remember that if you get a large amount of income that you were not expecting, you will need to adjust your withholdings so you do not end up owing the IRS a lot of dough.

4. You have the right to change your W-4 whenever you want to. If you have a life-changing event (marriage, inheritance) or anything like that which will require you to make a change, make sure you request a new W-4 from your employer and turn it in as soon as you can.

5. Claiming FALSE allowances on your W-4 is illegal. It is important to use your best judgement and caution when determining what allowances you are entitled to. Make sure that any allowances you claim are reasonably defensible, do not go overboard, and remember that taking too many risks is not worth the reward in this case.

The Facts

The following is a list of documents and forms that you may find helpful when doing your taxes and applying this little hint/method/trick.

1. Publication 17 - Page 39 has information about what will happen if you get busted abusing this method for getting your withholding correct.

2. Publication 505 - Information on Tax Withholding and Estimated Tax

3. W-4 - The infamous form!

4. Publication 919 - This one is one of the most important ones on this specific topic! This has a set of worksheets (starting on page 8) that help you determine how many allowances you should put down. This is the method William Wallets himself uses!

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