To prepare for future tax seasons, it’s best to start making adjustments to your withholdings now to avoid major surprises or penalties down the road. It doesn’t take an act of Congress to change your W-4, you just need to know who to contact. It is usually your Human Resources Department or Payroll Representative...and IF that is YOU, then you are two steps ahead of the game.
Why is Having the Right Withholding Important?
Every year about this time, I have a few of my clients contact me to ask me what they should change on their withholdings. Payroll withholding is something that every taxpayer needs to get JUST RIGHT. Why?
- If you don’t have the right amount taken out of your paycheck, you will end up owing money when you file your taxes. You may even owe penalties for underpayment.
- If you have too much withheld, you will receive a tax refund.
Although many people depend on a tax refund to provide them with a large amount of money every year, that is not always a good idea for everyone. A tax refund means you overpaid the government throughout the year, instead of putting that money to better use yourself throughout the year. For example, you could have earned interest on that money in a high-yield interest CD (Certificate of Deposit) or saved it in a 529 Plan for your child's education.
If you have the correct amount taken out of your earnings, it means that you won’t be surprised next year at tax time. Why is this important? Because if you do not pay what you owe by April 15th, you will be hit with penalties and interest. I don’t care if you pay it on April 16th, you WILL PAY a penalty of 0.5 percent of the total amount due per month up to 25 percent, as well as interest costs. These penalties are on top of any amount of underpayment penalties owed for not having enough taken out during the tax year.
You can discuss what the best withholdings are for you and your family with your tax preparer, or you can go to the IRS website (www.irs.gov) and do a paycheck checkup to ensure that you have the right amount of withholdings to avoid any penalties and also ensure that they are beneficial for your financial goals.
How to Make Withholding Changes
Again, it is best if you contact your Human Resources Department or your Payroll Specialist to make changes to your W-4.
Here are some steps you can take if you need to adjust your withholdings:
If you owe the IRS every year:
- Reduce the amount of dependent deductions on your W-4.
- Or, you can also initiate a set amount to be taken from each paycheck.
If you regularly get a huge refund:
- Increase the amount of dependent deductions on your W-4.
- The adjustment will give you a bit more cash in each paycheck. Don’t just spend it, but consider opening an account, savings, money market, IRA, or CD that will earn YOU (not the federal government) interest.
Here is a video that you can watch right now that will help you fill out your W-4 correctly.
When Should You Make the Change?
Well, of course, you should adjust your withholding any time there is a major change in your life, such as, getting married, having a child, getting a divorce, purchasing a home, or starting a business. However, there may be other circumstances that may make you want to change your withholdings throughout the year. I usually tell my clients who receive a large refund every year, that they should either change their W-4 to exempt or increase dependent deductions for six months out of the year to receive more income and decrease them the remaining six months to receive less income. During the first six months, you can take that extra money and save, invest, pay down bills, or take a vacation. During the last six months, you will live your normal life without any extra money. And, when tax time rolls around, you will still receive a refund, however, you will have had the opportunity to enjoy your earnings throughout the year and not just at tax time.