Let’s cover a few basics. What is the number of allowances that you currently have on your W-4? If you do not know, go find out now (look at your pay stub and/or look online). Did you get a tax refund, or did you owe money on last year’s return? Do you expect your income to be similar to last year? Will it go up, or will it go down? Answer these questions as best you can prior to moving on.
If you have 0 allowances on your W-4, that means you are having the maximum amount of taxes withheld from your pay. As you go up in numbers, you will have less money taken out (federal and state). You could have 3 people in your family, and because you have multiple tax deductions or credits, you may select multiple allowances. Your allowances should reflect how many family members under 17, deductions, and credits you have.
The goal here is very simple. At a bare minimum, you should strive to break even come tax time. If you want to really make the most of the situation, the goal would be to owe as much as possible (less than $1000 or 100% of last year’s taxes) without paying any penalties. This means you would make a change on your W-4 and raise your allowances to the highest number that would keep you under those two barometers.
Do not let anyone tell you how many allowances you should have on your W-4 (this includes co-workers, HR, family and friends). Only you know your tax situation, and only you should be deciding this issue. Click below to access the IRS withholding calculator. This will provide you with the link where you can put in your numbers and the calculation will do the rest. Withhold only what is necessary. Keep reading below!
Raising your allowances will increase your monthly paycheck. Let’s say you raise your allowances by 2 (reducing the future tax refund) and start receiving an extra $300 in each monthly paycheck (federal and state withholding taxes are reduced, FICA will not be affected because that tax is taken out from your gross pay no matter how many allowances you have). What do you do with the extra money?
Do not spend this money on crap you do not need. This defeats the purpose of raising your allowances. It will put you in even worse financial shape, because there will be no big refund coming next spring. Here is a list of places where this newfound money should go based on your particular situation. I would recommend you go down this list as you prioritize where the money could best be used.