Tweak Your Income Tax Withholding
Avoid Paying More or Less Tax Than You Owe
When tax season gets underway, you may be wondering whether you'll owe money this year or snag a large refund. While the deductions or credits you claim can determine your tax liability, it's also influenced by how much taxes you elect to have withheld through your employer.
Claiming too many withholding exemptions on the Form W-4 you file with your employer can result in underpaying your taxes for the year.
Claim too few withholding exemptions and you'll end up lending Uncle Sam your money interest-free. That's not as bad as owing, but why give up the interest on your money and the use of that money during the year?
For some people, withholding exemptions can be used as a type of forced savings account. The money is withheld until they file their taxes, then they receive it all back in a lump sum in the form of their tax refund. But, there are better ways to save.
For instance, it may benefit you more to adjust your withholding and have the extra money taken out of your paycheck or bank account automatically each pay period and transferred to a savings account. If you're keeping the money in a high-interest savings account, those regular deposits can grow more quickly over time, compared to a traditional savings account. If you don't believe in the power of small savings deposits, try tracking every penny you spend for a month.
I guarantee you'll be surprised (if not appalled) at how much a number of seemingly inconsequential amounts add up to.
The beginning and end of the year are ideal times to review your withholding strategy to ensure that you've claiming an appropriate number of exemptions. It's also a good idea to check your withholding periodically throughout the year to make sure you're not paying too much--or too little--in taxes.
After all, you don't want to be surprised with a large tax bill in April.
Chooosing Your Withholding
Ideally, you should claim the number of exemptions that will result in withholding as close to what you owe as possible. Your target number depends on your filing status, income and whether you have any dependents that you claim on your taxes. If you're confused by tax withholding worksheets, a relatively easy way to calculate your appropriate withholding is to plug the numbers into a tax withholding calculator.
It's particularly important to revisit your withholding if you've undergone any significant life changes in the last year, or if you owed taxes or got a large refund. For example, you'd need to complete a new W-4 and submit it to your employer if any of the following situations apply to you:
- You got a big refund last year
- You owed over $100 last year when you filed your tax return
- You got married or divorced
- You had a child
- You can no longer claim a dependent that you claimed last year
- You began caring physically and financially for an aging parent
Remember that if you're married and you and your spouse both work, you may need to account for the "marriage tax penalty," when determining your withholding.
This penalty results in married couples who file a joint return owing more taxes than two unmarried people with the same income would pay. Whether you're subject to the marriage tax penalty depends largely on your income. Under the recently passed Tax Cuts and Jobs Act, the marriage tax penalty has been preserved but only for the highest earners. Beginning in 2018, it impacts only married couples filing jointly earning an income of $400,000 or more. Filing separate tax returns could allow you to avoid the marriage tax penalty, but it may make you ineligible to claim certain credits or deductions, which could reduce your tax bill.
If You've Underpaid Your Taxes
If last year's withholding election has resulted in an underpayment of taxes for the year, don't panic. You have until the April filing deadline to pay the balance owed before interest and penalties begin to accrue.
Remember, the Internal Revenue Service offers an installment agreement for taxpayers who need a payment plan to satisfy their outstanding tax bill.
Alternately, you could use a credit card or personal loan to pay your tax bill if you'd rather not owe any money directly to the government. Remember that if you're going to use a credit card to look for one that offers the lowest annual percentage rate possible if you won't be able to pay the balance in full right away. And also be aware that the IRS may charge you a processing fee for paying your taxes with a credit card.