Guest post by Dawn Cook.
Now that you’ve watched my introductory video and you know generally what I’m talking about here, let’s get into the specifics:
Usually the only way you can increase the net pay in the paycheck you receive from your job is to ask for that most-desired raise, right? That’s an option that is not in our control and for many of us, we either don’t have the nerve to ask or have already been told all raises are on hold.
Well, you’ll be glad to have read this post today because there is another way for home-based business owners, like you, to increase their job paycheck and it is totally in their control. This technique creates an increase in W-2 net pay when the business owner needs it the most and that’s when they are just getting started. So it is so important that this option is explained to all new home-based business owners. It can even be one of those reasons that helps to make the decision to get started in a home based business.
Let’s begin to explain how it can work for you.
(First I have to say that this post here is specific to US Tax Law. If you are not a US taxpayer, then please consult with your own tax adviser to find if there is something similar in your country. I hope there is.)
First, the Form W-4:
Do you remember the Form W-4 you had to complete when you were first employed? On that form, you indicated if you were single or married and how many allowances you wanted to claim to determine how much federal income tax is withheld from you on each paycheck.
Normally this form is to be given to you near end of each year so you can make any adjustments for the coming calendar year. Most employers though do not make that an annual practice since they leave it up to you to inform them if you have any adjustments to make. As a home-based business owner, you will have adjustments to make every year and maybe even more than one change per year.
Second, by making adjustments on this Form W-4, you can either:
Reduce the tax withheld from your paycheck, your most likely situation in the beginning of your business, or
Increase the tax withheld from your paycheck when your business has grown and is generating an abundance of income.
Third, where do you go to get a Form W-4?
Either from your employer or you can go to http://www.irs.gov and find the form on that home page for printing. Be patient with this site. It is often hard to access due to multiple users.
Fourth, how do I determine what my number of allowances claimed should be?
Now you have the Form W-4 and probably wonder how to complete it to create a larger paycheck, right?
Okay, let’s go through an example:
New business owner’s original Form W-4:
1 allowance for herself
0 allowance for spouse since he is also employed and claims himself
2 allowances for two dependent children
3 total allowances
For 2011, each allowance claimed shelters $3,700 from the income subject to income tax withholding. Therefore, more allowances reduce the income subject to tax and reduces the income tax withheld, increasing the net pay. And the opposite is true. Less allowances increase the income subject to tax and increases the income tax withheld, decreasing net pay.
New business owner works with her tax adviser and estimates that the total direct business expenses will exceed gross business income by $10,000.
This creates an estimated taxable loss from the home-based business of $10,000. To determine how many allowances can be added to the Form W-4, the $10,000 estimated loss is divided by $3,700 and rounded down to nearest whole number, which is 2.
New business owners “revised” Form W-4:
1 allowance for herself
0 allowance for spouse since he is also employed
2 allowances for two dependent children
2 additional allowances for estimated $10,000 business loss
5 total allowances
The increase in net pay due to applying 5 allowances (sheltering $18,500 in wage income) rather than 3 allowances (sheltering $11,100 in wage income) will vary from person to person depending on wage income level and corresponding income tax bracket. Therefore, an example of actual net pay increase is not feasible here, but your tax adviser could do that precise calculation for you (OR if you followed my last post, you are working to become a tax expert yourself and can likely make a close calculation for yourself.)
Another reason to possibly increase your W-4 allowances:
I want to give another reason for an additional allowance you may be able to include in your revised Form W-4. If your itemized deductions will exceed the standard deduction for your filing status by over $3,700, you will be able to add an additional allowance. Again, you divide the expected excess itemized deductions by $3,700 and round down to a whole number.
Two Points of caution –
First, be conservative in your calculations. If you increase your allowances too high, you may owe taxes when final calculations are done due to reduced withholding and if your balance due is too much, a underpayment penalty may be imposed.
Second, the opposite applies too and is also not good. If you decrease your allowances too much, you may have a refund when you file your tax return. Yes, this is not a good thing. Any refund due from the IRS means you let them use your money for free all year when you could have invested it and earned money on it for yourself.
Do it every 3 months!
The biggest point I want to make here in this post is that you can adjust the number of your claimed allowances as often during the year as you see fit. I recommend that you do this calculation every three months so you can stay on top of things and receive the tax benefits of your home-based business during the year rather than waiting until you file your tax return.
The coming great news!
This technique of evaluating your tax situation every three months and taking advantage of all home business tax deductions will also apply when your growing business begins to generate a large profit. Then, it will be time to decrease your W-4 allowances (if you still have your job) so you won’t have a balance due and possible penalty when your tax return is filed. Once you don’t have the job anymore (and therefore no tax withholding), you can apply these tips of estimating your tax situation every three months so you can pay the minimum required quarterly estimated tax payments. It’s all about taking control of how much money you keep!
I hope this post helps you to take advantage of this little-known way to increase your job’s net pay when the situation applies and how to plan a bit as your business succeeds. I bet YOU can now increase your net pay faster than your boss will give you a raise!
Please leave your comments below.
Committed to Your Success!
DISCLAIMER: Dawn Cook is not a tax professional or tax attorney. Therefore you must consult with a tax professional before implementing any tax strategy.
See all the posts in this mini-series:
- Taxes – You Must Be Your Own Expert Whether You Like It or Not!
- Tax Tip – How to Use Your Business Expenses to Increase Your W-2 Paycheck
- Tax Tip – How to Save Taxes by Hiring Your Kids
- Tax Tip – How to Make your Trips Qualify as Deductible Business Trips
- Tax Tip – Business Travel – Make It Deductible with Accurate Record-Keeping!
- Tax Tip – More on Deductible Business Travel