Back on topic:
Post from a friend-of-a-friend: "2014 Taxes are done! Only owed Uncle Sam an additional $1008 and [State] an additional $186. I'm sure they will give it back someday... Not"
Response: "You had to pay in? here I was going to ask you for insight on getting the most out of uncle Sam!"
Because the goal is to get a tax refund, of course.
If only people would understand that the friend of a friend did it far closer to optimal than most Americans (dunno if that person ended up paying penalties for underpayment of tax, but even if he or she did, it can't have been all that much for that low a balance).
I believe the average tax refund for households in this country is $3k.
The W-4 is biased towards refunds. If you set the correct number of allowances and don't have any other income it is designed to overwithhold.
Wrong. If you answer the questions correctly, don't have any other income, and don't qualify for any tax deductions or credits the W-4 doesn't ask you about, the tax withholding will be exactly right (that is, so long as the employer follows IRS instructions).
Take Bob, a fresh college graduate. Single, no kids. No other sources of income other than a W-2 from a job.
Suppose Bob makes $50k. To make the calculations simple, assume no 401k, HSA, etc. (Or because we're Mustachians, just say that he reports $50k as wages on his tax returns after taking into account 401k and HSA contributions). When Bob fills out the W-4, it instructs him to claim 2 allowances - one for himself and one because he is single and has only one job.
Suppose Bob is paid semimonthly. Every paycheck his gross wages are $2083.33. IRS publication 15 is what employers use to calculate the correct withholding. Lets take a look at page 43. www.irs.gov/pub/irs-pdf/p15.pdf
Each withholding allownace for the semimonthly pay period is worth $166.70. Bob claims two allowances. Hence, $2083.33 - 2*166.70 = $1749.93 is subject to tax withholding on every paycheck. Now we jump to page 45 for the withholding tables.
On page 45, we find table 3, semimonthly payroll period. Use table a because Bob is single. Amount to withhold is (1749.93-1656)*.25 + 214.80 = $238.28.
Multiply this over 24 paychecks, and we get a total tax withholding of $5718.72.
What's his true tax liability? Let's calculate using the tax tables from http://www.forbes.com/sites/kellyphillipserb/2014/10/30/irs-announces-2015-tax-brackets-standard-deduction-amounts-and-more/
Standard deduction is $6300, exemption is $4000. Remember, Bob has nothing special for simplicity. No student loan interest deduction, no IRA, etc.
$50,000 - $6300 - $4000 = $39700 of taxable income.Tax liability
= (39700-37450)*.25 + 5156.25 = $5718.75
I'm three cents off, but that's just a couple rounding errors - not every paycheck is $2083.33 if you want his income to total to exactly $50k.
I could do the same exercise for a different pay cycle (biweekly, monthly, etc) and it will result in the same thing: tax liability = tax withholding.The W-4 is not biased towards refunds.
What happens is that for a large chunk of people, their tax situation is far more complicated than the short worksheet on the W-4 can handle. The only way to get your W-4 correct is to project your total tax liability for the year by taking into account all sources of income, tax deductions, and tax credits, and then manipulating the withhodling to match your projected tax liability. And then come November/December, check it again.
But the W-4 can't possibly ask you about all tax credits and deductions you qualify for because people aren't going to essentially project a full out tax refund when they fill out a W-4. Especially considering most Americans are clueless about taxes and wouldn't be able to do that without any assistance from software or an accountant.