Having the correct tax withheld for the year is important for a couple of reasons. Having too little taxes withheld and most likely you will need to pay taxes, and having too much withheld means that you will have overpaid taxes which you could have kept and used during the year, instead of getting it as a lump sum as a tax return. The IRS W4 form contains a worksheet that tells you how to compute tax withholding amount.
Here is a brief summary of how the IRS taxation system works. Every year the IRS requires pretty much everyone to file income taxes (with the exception of those who did not make enough). It is at tax time that people figure out and report how much income they have made in the previous year, and they also report how much taxes were withheld over the year (usually on W2 forms). Then using the IRS tax table one can find out how much taxes were due for the incomes that are reported. If the taxes due is less than the taxes that were withheld over the year, then the taxpayers get a refund, and vice versa.
As said before, the IRS W4 form is used to determine the tax withholding amount. To be specific, it determins who many "exemptions" that the taxpayers has. An exemption is kind of like an allowance that the IRS give to taxpayers. For example, one exemption is automatically granted to an individual taxpayer. If that taxpayer has two children then that taxpayer is given two more exemptions for his/her kids. On the tax return, a taxpayer's income is deducted by the amount of exemption the taxpayer has (one exemption translates to $3,200 for your 2005 tax return), thus reducing the taxpayer's "taxable income." In other words, not every dollar that you make in the last year is taxable. The IRS will only tax you on the amount of taxable income.
In summary, to compute the tax withholding amount for yourself, complete the form W4 provided by the IRS to figure out the correct number of exemption you can take. It is based on the number of exemptions that you are claiming that the IRS will withhold a certain amount of tax from your paycheck. If you are claiming more exemptions (thus, decreasing a taxpayer's taxable income), less taxes will be withheld; less exemptions (thus more taxable income) that are claimed, more taxes will be withheld.
