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Taxing Matters

By William Perez, About.com Guide to Taxes

For many people, having a big tax refund is immensely rewarding. There's a sense of satisfaction is learning that all the hours spent gathering documents and working through your tax software has paid off. But a large refund could signal that you can adjust your paycheck withholding so that less is taken out through the year.

There are a couple of things to keep in mind here. First, consider your financial planning habits. Some people prefer higher levels of tax withholding as a sort of forced savings account. The downside is that the Treasury does not pay interest on tax refunds, so you would come out ahead by lowering your withholding and putting that money to work for you inside an interest-bearing savings account. The second consideration is to figure out what your income and deductions might look like for 2010. The more accurate your estimate for 2010, the more accurately you can adjust your level of withholding.

Thirdly, it's important to understand how the math for withholding calculations work. Employers rely on "withholding allowances" on your Form W-4. The higher your withholding allowances, the less tax will be taken out of your paycheck. Allowances are not the same as personal exemptions, which relates to how many people are in your household for tax purposes, although they are closely related mathematically. Roughly, you should claim one withholding allowance for every $3,650 in deductions you expect to claim on your 2010 return. That $3,650 figure is the same amount as the personal exemption. Hence, many people will simply claim the same number of withholding allowances as they have personal exemptions (for themselves and their dependents). However you can claim higher withholding allowances if you'll have substantial deductions.

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