Can someone tell me about withholding?
 

If I have the maximum withheld from my income, shouldn't it pretty much cover my taxes? My wife and I file a joint return. We each claim no exemptions on our withholdings so as to have the max withheld. I do the same for my Navy retirement pension. We do not itemize and we take the standard exemption. We do not have a state income tax. I have one dependent child under 18. My AGI is 65K. Bottom line is I still end up paying a significant amount of tax ($600-$1200) over and above what was withheld. Is this normal? Thanks for any input.

I'll assume certain numbers based on your information. Let's assume that you military pension is $12,000/year and each of your salaries are $26-27,000/year. Withholding rates are based on that sole source of income, and other sources of income can not be assumed in those calculations. What does that mean? Taking the pension, when you indicate that you are withholding at Married 0 (or single 0), it looks at how much the taxes would be on that $12,000 as if it was your only income. Let's say the maximum taxes possible on that would be $2,000 (it isn't, but let's say it is.) Then you would have approximately $150-200 a month withheld.

Using the same theory with the other incomes, they would withhold based on their income alone, and withholding let's say 5,000/year. Combined we are looking at $12,000/year. Based on a standard deduction, 3 total dependents, you will be taxes on approx $50k. The taxes on this ends up being about $16,000. Each source of income withholds enough assuming it is the only source of income. Each alone would put you in the lowest brackets. The problem is, that you have mutliple sources and the brackets jump up and you end up short.

First option, review the withholdings. If you have the withholdings at M-0, switch them to S-0. This will have more withheld. Second, force an additional $20 a week of withholding (a little more than $1000/year). Third, leave it alone and put the $20/week into a savings account an earn interest on it. The last option is the "correct" answer for us professionals, assuming you aren't paying underpayment penalties, since you earn interest on the funds - the goverment doesn't give you interest on your refund. However, since most taxpayers want/expect a refund then your opinion may differ.

***Disclaimer*** The numbers used were approximations of income amounts and actual tax amounts. It's the weekend and I don't have my tax rate schedules at home. But the concepts are still accurate.

Thanks alot Bones for your reply. It is finally clear to me. I don't know if I have the discipline to save it in an account, surprising how many "emergencys" arise when I have some money set by. I will change my witholding as you advise, I thought I was already withholding the max. Too late for this year, but next year will be different! Thanks again for your time.

BonesCPA, could you please explain why the IRS has underpayment penalties? Shouldn't I be able to forego withholding altogether and just pay the tax due at the end of the tax year? Said another way, why should I be forced to give the government an interest free loan until tax time? I always get a refund and this year it could be quite substantial due to overpayment. I approached my payroll department about decreasing the amount withheld from my pay and I was warned severely about these penalties. What gives?

I thought of messaging you with this question, but I figure that the answer might benefit the group.

Thanks in advance for your input.

You're not giving the government an interest free loan, unless you're doing it wrong.

In most cases, you need to pay 90% of the current year tax or 100% of the prior year tax to be "penalty proof." This means either through withholdings or estimated tax payments. Interest charges, however, still apply.

Reason being is that you're being taxed as you make it, so cough it up in a timely fashion.