How to Owe Nothing With Your Federal Tax Return

It's possible to plan your taxes so that you don't owe anything to the Internal Revenue Service (IRS) when you file your federal tax return. You can do this by using your W-4 form to adjust your withholding.

While most employees know that you submit a W-4 when you start a new job, many don't realize you can submit a revised W-4 anytime. Here's how you can manage your withholding to get your tax payments just right.

Understanding Tax Withholding

Form W-4 is the form you fill out for your employer when you start a new job. This determines what percentage of each paycheck will be withheld to pay your taxes. How much is withheld throughout the year determines whether you will owe money when you file your tax return. If not enough is withheld, you will have a tax bill to pay when you file your tax return in April. If too much is withheld, you will be entitled to a tax refund.

While a tax refund may feel better than a tax bill, it's not an ideal situation either. "It's not always a huge win to get a tax refund because that means you've lent your money to the government," says Melissa Joy, CFP, CDFA, the president of financial planning firm Pearl Planning. "You could be using that money throughout the year and keeping control of it yourself."

The ideal situation when you file your taxes is that your withholding and tax liability match up perfectly, with no tax bill or refund in sight. To achieve this balance, you need to start by finding how much income tax you will owe for the year.

How to Estimate Your Annual Tax Liability

If you have a salary and a regular paycheck, you can calculate your total tax liability based on your annual salary. However, more than half of workers in the U.S. are paid hourly rather than by receiving a salary.

If you are paid hourly, receive commissions and tips, or otherwise don't have a consistent income, it becomes harder to calculate your annual tax liability. You'll need to estimate your annual income based on your previous earnings. Once you have a reasonable income estimate, you can use one of several methods to estimate how much tax you'll need to pay.

1. Online Calculator

A free online paycheck and tax calculator can help you estimate your yearly tax liability. Many can be found through an online search. For most of them, you'll need to put in your:

• Total pay
• How frequently you are paid (weekly, monthly)
• Federal filing status (single, married filing jointly, head of household)

Some may ask for additional information as well. Once you input your information, the calculator will tell you your tax liability. You can select how much tax you'll owe for the whole year or how much you will owe per paycheck.

Using an online calculator is quick and will produce a reasonable guess of how much tax you owe. However, it won't be a perfect estimate because these calculators don't include other factors, such as tax deductions or tax credits.

2. IRS Withholding Estimator

The IRS website has a free tax withholding estimator. It takes longer than an online calculator, but the result will be more accurate.

In addition to questions about your total pay, filing status, and other basic information, this estimator will also ask about:

• Tax credits, such as for child or dependent care
• Tax-deferred retirement plan contributions
• Any Health Savings Accounts (HSAs)
• Current withholding from your paycheck

The IRS estimator will calculate your tax due for the year. It will also tell you how much you are on track to pay through withholding and whether this will produce an over- or underpayment.

3. Sample Tax Return

Calculate your tax due by completing a sample tax return using tax software or by hand. Use the most up-to-date forms available, as tax rates and rules can change each year. This method will take the most time but will be the most accurate.

How to Calculate Your Withholding

Once you've calculated your total tax bill for the year, your next step is calculating how much you need to have withheld each pay period to come as close to that number as possible. Divide the total by the number of pay periods you expect to have in the year. For example, if you are paid once a month, you'll have twelve pay periods. If you're paid every week, you'll have 52.

How to Adjust Your Withholding

Once you've calculated what your withholding should be per pay period, compare that number to your most recent paycheck. If the numbers match up, you're set for the year.

If they don't, however, you'll need to fill out a new W-4 form. You can print one from the IRS website and deliver it to your employer or HR department. How you fill out the form will depend on whether you're paying too much or too little tax.

If You're Underpaying

If you're going to owe money when you file your taxes in April, that means you are underpaying because your employer is withholding too little. To fix this, you can withhold additional tax to make up the difference.

The W-4 form has a line where you can enter how much additional tax you would like withheld each pay period. You could also claim fewer withholding allowances on your W-4, which will be less accurate than writing in a specific number.

If You’re Overpaying

If you're going to get a tax refund when you file your taxes, that means your employer has withheld too much and you're overpaying. You can increase the withholding allowances claimed on your W-4 to have less withheld from your paycheck.

The simplest method for deciding how many to claim is to use a paycheck calculator to check the results of different holding allowances until the result is as close as possible to your remaining tax liability for the year.

If you use this method, remember that the IRS requires you to have a reasonable basis for your withholding allowances. You may be fined or penalized if you intentionally provide incorrect information on your W-4.

Remember, if you underpay your taxes, you may be subject to penalties and interest separate from the penalties for providing incorrect information. You can avoid these penalties by ensuring that your withholding is equal to the smaller of:

• 90% of your current year's tax liability
• 100% of your previous year's tax liability (or 110% if your AGI was $150,000 or above)

The Bottom Line

It's possible to avoid owing the IRS any money when you file your tax return. If you calculate your withholding, you can use that number to determine whether you're currently over- or underpaying your taxes. Use that information to fill out a new form W-4 as often as you need throughout the year, and you'll be set when tax time comes in April. Just be careful not to underpay so you can avoid penalties and interest.