When You Should Change Your Withholding Tax – Investopedia



Tax withholding is often seen as a mysterious science where it is better to err on the side of caution and not “to tamper with laws of nature that man was never meant to know!” Sensationalism aside, paying attention to and adjusting your tax withholding via Form W-4 is an important way to ensure you are not under- or over-withholding your tithe to Uncle Sam. (Understanding The U.S. Tax Withholding System first is crucial to getting it right.)

TUTORIAL: Personal Income Tax Guide

Another Tax Form?!

The chances are that you know the W-4 even if you don’t remember it. It is the basic form you fill out every time you start a new job. Because the United States tax system is a pay-as-you-go one, there are two choices when it comes to payments: withholding or paying estimated tax. Estimated tax payments are used by business owners, the self-employed and some corporate employees with large amounts of dividends, royalties or other significant income streams beyond their 9-to-5 job wages.

For those who are on a company payroll, the federal government requires that your employer withhold part of your income for taxes. This money, your “witholding”, is deducted from your paycheck before you receive it, and sent to the IRS. To calculate the amount to hold back, your employer relies on the information on your Form W-4. So, how you fill out your W-4 ultimately determines how much of your income is withheld from your paychecks.

YFactors that influence your withholding rate include the amount of income you earn, the validity of the information on your W-4, any dependents, spouses or other withholding allowances you may have, and whether you want additional funds withheld. The aim is to have as little money withheld as possible. If too much has been withheld, you may end up seeing a refund after filing your tax return in April.

Events That Trigger Changes

Your withholding is made up of three basic pieces of information:

  • Whether you are using a married or single rate
  • What allowances you qualify for
  • Whether or not you want to withhold extra funds

Changes in your household situation – one spouse loses a job, a child is born and so on – can have an immediate impact on your tax situation. In these situations, it is well worth changing the amount of witholding to avoid owing a big tax bill or essentially loaning the government extra money at zero interest.

Will You Marry Me?

Don’t say yes just because you love filing updated W-4s, but do keep in mind that marriage will affect your taxes in one of two ways. One, if your spouse has an income coming in, your overall household withholding may go up. Two, if your spouse doesn’t work, your overall withholding will likely go down. These scenarios assume that you two will be filing a joint tax return. (Not sure whether you should file jointly or separately? Check out Happily Married? File Taxes Separately to learn about situations where the separate filing makes sense.)

You Ruined My Life and My W-4!

Of course, marriage isn’t always a permanent arrangement. A divorce can change your tax situation in a couple of key ways. It will, of course, alter your household income, but there is also the matter of alimony. If you are paying alimony, you can adjust your withholding to reflect that by filing a new form. If you are receiving alimony, you have to pay the tax on it and will have to file a new form as well. (To learn more about taxes following a divorce, check out The Fundamentals Of Spousal Support Taxation.)

And Baby Makes Three

Having a baby, while perhaps not all fun and games, does mean new allowances that should reduce your withholding. Adopting or giving birth to a child immediately adds a dependent to your household and lessens the overall tax burden to compensate for the expenses that come with raising children. Of course, this also means that when your children grow up and move out, you have to adjust your withholding back up.

The New Digs or New Deductions

When you purchase a home, you will need to update your withholding for the expected tax break. Of course, you can leave this until the end of the year, but opportunity cost shows us that money now is worth more than money further down the road. The same is true with any large deductions or credits you will become eligible for within a given year, be they education credits, dependent care expenses, charitable giving or any of the others.

Big Increases in Non-Wage Income

Any non-wage income, whether from a side business, stock dividends, interest income, etc., will come as a surprise to the IRS – and an unpleasant shock for you – if you don’t adjust your withholding to reflect the extra cash. Remember that the W-4 is aimed at reflecting the average American household’s income. If you are seeing significant amounts of income from sources other than your 9-5, you will need to withhold more or begin paying estimated tax to avoid a big bill at tax time.

Working Two Jobs

According to the IRS, most withholding disparities are created by changes in employment. If you are working two jobs, you can split your allowance between them, but you cannot claim double the allowances (that is, claim the same allowances twice). Similarly, losing that second job means that you can reduce the withholding on your remaining job or claim allowances that you were previously holding off on.

Getting Your Withholding Right

The IRS provides a very good withholding calculator on IRS.gov that can help you account for these credits, but they will not do it for you. Simply put, they don’t mind paying out refunds at all, and it is not worth adding the salaries needed to make sure amounts from everyone’s wages are being withheld at the proper level.

Form W-4 usually comes with a guide for calclulating your withholding. The IRS also provides worksheets for converting credits to withholding allowances and tips about common errors. For example, you cannot claim the same allowances as your spouse, but you can split them up as needed. The chances are very good that you will learn something new by reading through the relevant publications.

The Bottom Line

It may seem like there are many circumstances that will require you to adjust your withholding. In reality, most people will go years without having to significantly alter theirs. However, if any of these changes do occur, it is well worth the time to re-file the W-4. Best-case scenario, you are giving too much to the government; they will return it to you – without interest. Worst case, you’ll owe a big chunk of change and, oddly enough, they’ll be charging you interest on that until you pay it off. But even if you never encounter many changes, it’s important to understand where that money coming out of your paycheck goes and why. After all, you earned it. See Tax Withholding: Good For Government, Bad For Taxpayers.)



Source link