Cut Your Tax Withholding and Give Yourself a Raise

If you expect a large income tax refund from the Internal Revenue Service (IRS) on your 2010 taxes, now is the time to resolve to stop giving the Federal government interest-free free loans and to give yourself a raise instead. Here are 4 tips to help you break the cycle of paying the IRS too much too soon.

Call a spade a spade. If you view your income tax refund as a bonus or "found" money that can be used to splurge on something special for yourself, it is time to revise your thinking. In reality, when you receive a tax refund, you are just getting your own money back, after letting the Federal government use it interest free, sometimes for a year or more.

Know the tax withholding rules. Some taxpayers have too much tax withheld from their pay because they fear that the IRS will hit them with penalties and interest if they underpay taxes during the year. In fact, it is easy to avoid a tax penalty as long as you know the withholding rules. For example, you will not be charged a tax penalty if you owe less than $1,000 in taxes when you file your return, if you paid at least 90% of your total income tax liability for the year, or if you paid at least 100% of your prior-year income tax liability (high earners must pay more).

Give yourself a raise. If you regularly receive an income tax refund, now is the time to lower the amount of tax being withheld from your paycheck and give yourself a raise. In order to determine how much should be withheld from your pay, you'll need to estimate your tax liability for the year.

If your monthly income is relatively stable and you expect this year's income and deductions to be about the same as last year, your prior-year tax liability, as shown on your most recent tax return, may be a good ballpark estimate of what you will owe this year. Divide it by twelve to estimate your monthly withholding and then compare this figure to what is actually being withheld from your paycheck. If actual income tax withholding is meaningfully higher than your estimated tax liability, contact your company's payroll department about how to reduce the amount that will be deducted from future paychecks so that withholding for the full year is closer to your expected tax liability.

If your income is likely to be significantly higher or lower this year than last year or you have a complicated tax situation, you may want to consult a tax professional to help you estimate the correct amount to have withheld from your pay.

Consider saving the increase in your paycheck. If you have the amount of income tax withheld from you paycheck reduced, consider tucking that money away in your retirement fund. After all, you won't miss it, since you were getting by without it prior to changing the withholding amount. Also, putting it in savings could give your long-term retirement plan a nice boost.

Sources:

Jeff Schnepper, money.msn.com , Why I hate income tax refunds - IRS & tax returns - MSN Money

Bobr, www.superaccounting.com , Avoid Tax Penalties /Superaccounting.com

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