If you typically receive a large refund from IRS
after you file your income tax return, or you owe the IRS a substantial amount
at that time, you should consider adjusting your income tax withholding.
Your employer withholds income tax from your paycheck
based on the number of withholding allowances you claim on Form W-4, Employee's
Withholding Allowance Certificate. You must give your employer a Form W-4 when
you first begin work.
If your tax circumstances change, it's up to you to
give your employer a new W-4. Many employees neglect to take this step,
resulting in withholding that is either too high or too low.
If your withholding is too high, you are in effect
giving the government an interest-free loan. Although the overpaid tax will be
refunded once you file your return, you would have been better off using the
money during the year to generate income or for personal purposes. In this
case, you should reduce the amount your employer withholds to increase your regular
take-home pay.
At the other extreme are taxpayers who have too
little withheld and who owe substantial amounts come April 15th. While they
enjoy the "extra" amounts received in each paycheck, they must pay
back the taxes owed in April, and will likely be tacking on extra in the form
of penalties. If this is your situation, you should increase your withholding.
As a rough guideline, you should owe less than 10% of your tax bill come April.
Even if you have had too little tax withheld for most
of the year, you still may be able to avoid a penalty by asking your employer
to withhold additional amounts for the rest of the year. This is because the
increased withholding at year's end will be treated as paid equally throughout
the year.
You should check your withholding whenever
significant personal or financial changes occur in your life, including the
following:
• Changes in filing status or exemptions: You get
married or divorced; you have a new child; a child goes off on his or her own.
• Changes in wage income: You or your spouse start or
stop working, or start or stop a second job.
• Changes in income not subject to withholding: You
have an increase or decrease in rental income, interest income, dividends,
capital gains, or IRA distributions.
• Changes in deductions and credits: You take out or
pay off a mortgage; you become entitled to the dependent care credit, child tax
credit, or the higher education credit; you have changes in medical, alimony,
or job expenses.
• Changes in other taxes: You owe self-employment tax
or employment taxes for your household workers.
Unfortunately, the procedures for arriving at the
proper withholding amounts are among the more complex ones taxpayers confront.
A wide array of factors play a role: exemptions, deductions, credits, marital
status, your spouse's income, and others. The Form W-4 includes three
worksheets that you may have to complete to determine the proper withholding.
If you think your situation calls for a withholding adjustment (up or down),
and you would like some guidance in getting through this maze, please contact us.
