How to Get a Smaller Tax Refund in Order to Keep More Each Month
Often when we think of tax refunds, we think getting the biggest tax refund possible is great. But it may be better to keep more of your money each month by having less taxes withheld from your pay.
This may help you pay your bills, pay off debt faster, or boost your savings.
But you probably don’t want to owe taxes when you file your tax return. Let’s explore how to get that smaller refund while avoiding owing when you file your tax return.
The IRS W-4 Estimator
The IRS provides a tool to help manage your tax withholding and refund size, the tax withholding estimator. This tool is only as good as the input.
It can support situations where there are multiple jobs and other sources of income. And you can factor in deductions and credits. At a minimum, you’ll need your last pay stubs to use this tool. But I recommend you also have handy information from other sources of income as well as your previous tax return.
If your income changes or if your tax situation changes (maybe you won’t be claiming a child), you need to revisit your estimation and your tax withholding.
I like to set my withholding in December or January, check it again when I file my tax return and at least one more time in the late summer or early fall. If your income goes up and down a lot, it should be checked more frequently.
It can be a good idea to give yourself a safety margin. Let’s say you have been getting $8,000 tax refunds. Maybe for the first year, you try to reduce that shoot for a $2,000 tax refund. That way, if you are off the mark, you’ll be less likely to owe when you file your tax return.
The Annual Tax Liability Method
This method is more complicated. For this method, you determine your tax liability for the whole year and then do some math to determine how much tax withholding you should have each month or each paycheck.
You can use a tax estimator or calculator you find online to determine the tax liability. Choose one that best fits your situation.
You could enter your new tax year information in the previous tax year’s tax return software and see what result it gives – without trying to file and without paying for filing. However, the tax return method to estimate tax liability will be off due to changes that happen each year with taxes.
Once you have an estimate of your total tax liability for the year, divide it by 12, and then you have your monthly tax liability.
If you have just one job you can divide it by the number of pay periods instead. That will give you the taxes that need to be withheld for a month or the pay period. Then you have to look at how much is being currently withheld for each job and adjust the W-4’s as to what is appropriate. I like to adjust the W-4 withholding such that once it is set I only have to tweak one of them to get it right.
If you have to increase withholding, this is the easiest way:
On line 4c of the W-4, put in the increased amount of withholding that is needed each pay period. Everything else should match what you previously submitted. And submit the form to your admin or HR.
Lowering your withholding is harder:
Just using the IRS tax withholding estimator is easier, but if you want to try this method, you could compare it to the IRS tax withholding estimator. Every dollar that ends up in line 3 (step 3) should lower your annual tax withholding by that much. For the current form and current law for 2022, this means you can adjust by $2,000 increments and $500 increments.
So let’s say you want to lower your annual tax withholding by $4,000. You can enter $4,000 on the “other dependent” line of step 3 and enter it again at the line for the total for step 3. When the W-4 is submitted and processed, they will adjust your paycheck withholding such that your withholding for the year is $4,000 less.
But what if the amount you want to lower it is not a multiple of $500? Let’s say it is $3,800 for the year. Then you enter $4,000 for the “other dependent” line and for the total line in step 3. And on line 4c you enter the result of X = $200/(number of pay periods). The net result should be $3,800 for a year.
Realize if you make the W-4 adjustments after you have already had some income for the year, you’ll have to account for the taxes already paid. This is another reason that the IRS tax withholding calculator is a simpler method.
If you don’t need any tax withholding to meet your tax obligations, you may claim exempt on your W-4. You would write “exempt” in the space under line 4c. You can find more information for claiming “exempt” in the W-4 instructions.
Check and double check
Once you make a change in your tax withholding, check and make sure the change goes into effect. And check to make sure you are on track in late summer or early fall, particularly if you are cutting it close to a zero refund.
Taxes and tax withholding doesn’t always make sense to everyone. If adjusting your withholding isn’t making sense to you, just follow the W-4 instructions exactly or play it safe. Playing it safe may mean keeping it the same even if you are getting a bigger refund than you may prefer.
Or maybe it is a good idea to consult a tax professional. If you already have a tax professional you use, they may provide some tax withholding analysis and advice for free. Ultimately, you are the one who has to make the best tax withholding and tax refund decision for you.