Recently, the IRS issued a statement urging taxpayers to double check their withholding status. That simply refers to the amount of income tax your employer withholds from your paycheck. Wondering what and why you need to double check? Here’s what you need to know.
What Happens If You Don’t Withhold Enough?
If your withholding is too low, you could be surprised by a tax bill at the end of the year. An unexpected tax bill could put a huge kink in your budget. Worst of all, if you don’t have money to pay right away, the IRS will assess penalties and interest.
What Happens If You Withhold Too Much?
Some people overstate their withholding on purpose because it means they get a refund at the end of the year. If you have trouble saving, this can be an effective way to generate a big chunk of money all at once, and many people love big tax returns. However, when you let your employer withhold more than needed, you are actually loaning the IRS money for free. If you change your withholding and use the extra money in your paycheck to pay down debt, you actually come out ahead financially. You also come out ahead if you put the money in a retirement account or an interest-bearing savings account.
When Should You Check Your Withholding?
Your withholding is based on your marital status, the number of dependents, and several other factors. Here are the key situations where you may want to check and change your withholding:
- You unexpectedly owed tax last year
- You got married or divorced
- You have a new child or dependent
- Your child no longer qualifies as your dependent
- You are starting to qualify as head of the household
- You no longer qualify as head of the household
- You plan to start or stop taking a deduction for childcare expenses (daycare, nanny costs, etc)
Additionally, if you got a refund and you want to just get your money upfront in your paycheck, you should also review your current withholding status. As of 2017, the IRS says that refunds may take longer than usual, especially if you get the earned income tax credit. That’s another reason you may want to change your withholding and just get your money upfront.
How Does Withholding Work?
Based your marital status, the number of dependents, and other details mentioned above, you get assigned a withholding number. The higher the number, the less income tax your employer withholds from your paycheck. The lower the number, the more income tax gets withhold.
For instance, if your number is 0, your employer withholds a lot more income tax than if your withholding number is 7. Some paycheck stubs have your federal withholding number on them, but in other cases, you need to speak with your boss to find out about your current status.
How Do You Change Your Withholding?
To see if you should change your withholding, you may want to start by using the IRS’s online tool. Otherwise, speak to your boss or the person in charge of human resources. To change your withholding, you need to fill out a new W-4 form.
The W-4 requires information on marital status, head of household information, number of dependents, and childcare expenses. It also has a worksheet to help you figure out how your spouse’s income or your income from another job affects your withholding. Based on all that information, the worksheet generates a number for you.
However, you can change the number if you want. For instance, let’s say that the W-4 recommends withholding at a 5, but you run a small freelance business and you want extra income tax withheld to cover income taxes from those earnings. In that case, you may want to request a lower number.
Ultimately, the most important thing is to set your withholding so you don’t face a big, unexpected tax bill at the end of the year. If you already have a tax bill due to claiming the wrong withholding status or for any other reason, we can help. Fill out the form at the top of the page to get more information.