Every year, Americans are seen scrambling around at the last minute to gather documents, chase deductions or arrange payment plans. All of these could have been avoided with just one simple action. The Internal Revenue Service (IRS) has sent out a consistent message to all taxpayers who want to avoid a financial shock next year. The message is simple. It says they should “check their withholdings”. This would help to protect yourself from unexpectedly large bills or disappointing refunds.
While the instructions may be too simple to worry about, the truth is that this is one of the major steps to take to be in control of your tax life.
What is withholding and how can you get it wrong?
On every income you earn, whether from a job or a freelance work, or from other sources, the IRS expects you to pay taxes on that income for the rest of the year. For most employees, this tax is withheld from each paycheck by their employer and sent directly to the IRS. This is what is known as withholding.
In this case, your employer determines how much to withhold based on the information you provide on your IRS form W-4. Details like your income, marital status, number of dependents, and other factors that influence your tax situation are contained in this form. So ideally, your tax should match your actual tax liability.
When you do not withhold enough tax, you could be faced with a large bill when it is tax time. And it might not just be your due balance, you may also owe penalties and interest for underpayment. If the case is over withholding however, it means the government has held your money all interest free.
The IRS reported that nearly 30 million taxpayers owed taxes when they filed their returns. Quite a number of them were left unprepared and shocked at this reality.
This is the reason why the IRS has become more vocal about encouraging tax payers to conduct a “paycheck checkup” at least once a year.
Factors that can change your withholding needs
It is important to know that the tax laws change, income fluctuates, and life moves in ways that shifts your financial life a great deal. This can directly have an impact on your tax bill.
Here are a few factors that might change your withholding needs:
- Marriage or divorce
- Getting a second job
- Having a child or losing a dependent
- Switching to a higher paying job
- Loss of a job or a significant reduction in work hours
- Buying or selling a house
- Freelancing income or self employment
The failure to adjust your withholding in response to these changes is like steering a car with blindfold on. You will most likely crash when it is tax time.
To easily check your withholding, the IRS offers a free tool called the IRS Withholding Estimator. This tool will help you estimate your tax. It also tells you if your withholding is too high, too low, or just right.
Some basic information you will need to provide before using the estimator includes:
- Recent pays
- Your most recent tax return
- Information about other sources of income, credits and deductions.
The estimator will subsequently guide you through a series of questions and provide a personalized recommendation.
