Understanding Tax Terms

The process of taxation is confusing to a lot of people.  It helps if you understand the terms being used.  I’m going to discuss them in chronological order, as they happen in the taxation process.

W-4 Employees Withholding Allowance Certificate

The W-4 is the form that you fill out to help your payroll office know how much money to withhold from your income.  On this form, you indicate the number of allowances you are claiming.  You can also ask for additional money to be taken out, if you have a special situation that requires it.  There is also the option to claim that you are exempt from withholding for certain reasons.

Lots of people think that they have to list the number of allowances that they come up with when they fill out the worksheet above the form.  However, this worksheet is a tool and it is designed to cover an average situation.  Very few of us are average!  You want to be claiming the right number of allowances to allow you to owe or overpay the smallest amount of taxes.  Sometimes, this takes some trial and error.  You also have to recalculate every time you have a change in employment status, dependency status, or if you suddenly have a large number of itemized deductions.

Military members can change their W-4 form at any time via the MyPay system.

Withholding

Withholding refers to the amount of money that your employer takes out of your paycheck to pre-pay your federal income taxes.  This amount is determined by your income and the information that you’ve put on your W-4 form.  This is not how much tax you are paying, it is just a pre-payment towards your yearly tax bill.

Tax Return

Your income tax return is the yearly accounting of all of your income, deductions, exemptions and credits.  Federal income tax is calculated on a yearly basis.  You show all your income, add and subtract various deductions, exemptions and credits, and come up with the amount of tax that you owe on your income for the year.  This is your tax liability for the year, or your total tax.  You then subtract the amount that you’ve already pre-paid via your withholding to come up with an amount that is still owed, or an amount that you have overpaid.

Taxes Owed

Sometimes called a tax bill, this is the amount that you have underpaid when comparing your total tax liability with the amount that you have withheld throughout the year.

Tax Overpayment

This is often called a tax refund because it is a refund of the amount that you have overpaid in taxes, when comparing your tax liability with the amount that you have withheld throughout the year.

I feel strongly that everyone wants to make sure that their withholding is correct so that they have a very small amount of taxes owed or taxes overpaid.  The idea is that you are withholding just the right amount.  It can be hard to get the amount correct.  I recommend that people start small, adjusting their allowances and additional withholding by just a small amount if they are underpaying or overpaying during the year.  If you start feeling more confident, you can then make adjustments throughout the year.  I usually try to review our tax withholding every few months, estimating what our total tax liability will be at the end of the year and seeing if our withholding is on track to come close to that amount.

Please remember that there are penalties for large under-withholding, so you are better to err on the side of withholding a little more than you think is necessary.

 

 

About the Author

Kate Horrell
Kate Horrell is a military financial coach, mom of four teens, and Navy spouse. She has a background in taxes and mortgage banking, and a trove of experience helping other military families with their money. Follow her on twitter @realKateHorrell.