It’s tax season! Whether you’re still filing your taxes or you’ve already done so, this is a good time to take a look at how much you designate for your employer to withhold from your paycheck. That amount can have a huge impact on whether you receive a refund or you owe money to the IRS come April 15.
I learned this lesson the hard way: During our second year of marriage, my husband and I were running behind getting our tax information together. When we finally got it over to our accountant, she only had a few weeks to prepare our return. A few days before the deadline, I received a call from her. It turned out that we owed about $3,000! Honestly, it took my breath away. Up until this point, when my husband and I had filed separately — as well as the previous year when we had filed together — we had always received a refund. This particular year, we expected to receive even more back since we had bought our first house and could enjoy the tax benefits of home ownership.
We were in shock. What had caused this problem — was it the money we had taken out of an investment account to use as a down payment on our home? While that certainly didn’t help, it wasn’t the biggest issue. Our accountant said we likely needed to change our tax withholdings. As a couple, we weren’t having enough taken out of our paychecks. We were both so used to filling out our W-4s as single people that we never thought to adjust those rates now that we were married and filing jointly, and our combined income put us into a new tax bracket.
I’m glad to say we got our bill to the IRS paid … thank goodness for our emergency fund! After that, our first stop was our HR departments to change our withholdings so we wouldn’t get burned again. While that didn’t change anything for the prior tax year, it did have a positive impact on the next tax year.
Want to make sure you’ve got your tax withholdings in line? Here are a few steps to follow:
1. Understand the System: A withholding allowance (0, 1, 2, 3, etc.) on your W-4 is essentially an exemption from paying a certain amount of income tax. So, when you claim an allowance, you’re telling your employer (and the government) to withhold less tax. If you claim zero allowances, you will have the maximum tax withheld. The more allowances you claim, the less tax is withheld. If you have too many allowances, you’ll likely owe on your taxes. Too few allowances, you’ll likely receive a refund — but you may be forgoing some money you could have received throughout the year. Check out this smart assets article to learn more about the withholding process.
Tip: You’ll want to double check your withholdings any time you experience a life change — marriage, divorce, birth of a child, starting a new job, a promotion, or a raise. You can change your W-4 at any time, so you don’t need to wait until the next year if you have a life change mid-year.
2. Check Your Paystubs: Not sure how much money is being withheld now? Take a look at your paystub. You’ll see the amount of money withheld for taxes, though not the amount of allowances you claimed on your W-4. Take note of how much your employer is withholding for both federal and state taxes. You’ll want to have this in hand as you calculate what your withholdings might need to be in the future.
Tip: If you are married and filing jointly, make sure that you have both your and your spouse’s paystubs. Just having one isn’t all that helpful.
3. Calculate Your Withholdings: Make sure you have your paystubs and your most recent tax return handy. There are a variety of different calculators you can use, including one directly from the IRS. Personally, I think this one from Turbo Tax is a little more user-friendly, and it’s quite thorough.
Tip: If you don’t file your taxes on your own, ask your accountant for help with this as part of the tax filing process. They should be able to quickly do this calculation so you have the right amount withheld for the next tax year.
4. Adjust as Necessary: If you find you need to make a change, talk with your Human Resources department to fill out a new W-4. This shouldn’t take more than a few minutes, but it could make a big difference for what you might owe (or be refunded) on next year’s return. You can not only change your number of allowances on your W-4, you can also specify specific amounts you want to have withheld for state and federal taxes. That’s particularly helpful if you — like me — live in a state with a higher income tax rate.
Tip: Once you’ve submitted this change, be sure to keep an eye on your (and your spouse’s) next paystub to make sure it was applied and the right amount is being withdrawn from your paycheck.
While I can’t provide tax advice, if there are tax questions you’d like for me to address in the future, contact me.
During this week’s Facebook and Instagram Live on Thursday, Mar. 28 at 8pm (Central), I’ll share a few ideas of things you can do with that tax refund and a couple next steps to take if you ended up paying in more than you expected this year.