In the U.S. tax system, most individuals take the pay-as-you earn (PAYE) approach, in which estimated income tax is paid throughout the year and then accounted for on tax day of the following year. Taxpayer's employers are legally required by the federal government to withhold part of their employees' income for taxes by deducting a portion of their regular paychecks. Show
To calculate the precise amount they withhold, employers rely on the information all new employees fill out on their Form W-4 forms. If too much tax is withheld, employees receive refunds. However, a lot can change over the course of a year. In certain circumstances, it makes sense to revise the amount of tax that gets withheld. Key Takeaways
When You Should Change Your Withholding TaxMost individuals have until April 18, 2022 to file their 2021 federal income tax return. Taxpayers in Maine or Massachusetts have until April 19th due to Patriots' Day in those states. All taxpayers that request a filing extension will have until Oct. 17, 2022 to file. Events That Trigger ChangesThe amount of taxes withheld is governed by the following considerations:
Changes in your household situation, such as the birth of a child or a spouse losing a job, can immediately impact your tax situation. In these situations, it is well worth changing the amount of withholding to avoid owing a bigger tax bill than necessary. MarriageIf you are married and filing a joint tax return, your taxes may be impacted in the two ways. First, If your spouse earns an income, your overall household withholding may increase. Second, if your spouse doesn't work, your overall withholding will likely decline. There are also situations in which separate filing makes sense. DivorceDivorce can alter your household income, but there is also the matter of alimony. Alimony began receiving a different tax treatment starting in 2019 thanks to the Tax Cuts and Jobs Act signed into law in 2017. Under the new tax paradigm, alimony payments will no longer be tax-deductible for the payer, while recipients do not have to declare alimony as income. Birth or AdoptionThe birth or adoption of a child immediately adds a dependent to your household and lessens the overall tax burden, in an effort to compensate for the costs of raising children. To capitalize quickest on the credits and increased deduction, consider reducing your withholding. When your children grow up and if they move out, you should consider readjusting your withholding as you may no longer be eligible to claim them as a dependent. New Home (or Other Major Purchases)When purchasing a home, you can update your withholding in anticipation for tax benefits. There are number of credits for first-time homebuyers, and the list of tax benefits approved by the IRS regularly changes. This holds true with any large deductions or credits you may become eligible for within a given year, including education credits, dependent care expenses, medical expenses, and charitable donations. Big Increases in Non-Wage IncomeYou must adjust your withholding to account for any non-wage income from side businesses, stock dividends, or interest income. For example, if you successfully invested and sold equities or cryptocurrency for a profit, those proceeds are subject to short-term or long-term capital gains depending on your holding period. Working Two JobsTwo-income households and individuals who work multiple jobs are vulnerable to withholding disparities. This is especially true if each withholding certificate is completed to withhold an amount specific to each job. For example, working two different jobs that each pay $25,000 pushes a taxpayer into the 22% tax bracket in 2021. However, independently, each withholding certificate may assume the taxpayer caps out in the 12% tax bracket. Similarly, losing a second job allows you to reduce the withholding on your remaining job or claim allowances you were previously holding off on. Getting Your Withholding RightThe IRS provides features a useful withholding calculator on its website. In addition. Form W-4 has instructions along the form in addition to a separate set of instructions. An overview of the steps to revise your tax withholding is below.
Coordinating with SpouseWhile you cannot claim the same allowances as your spouse, you cansplit them up Is It Better to Withhold More or Less Taxes?If you want to avoid paying taxes as part of your tax return, it is better to withhold more taxes. However, there is a lost opportunity when withholding more than you need. By overpaying taxes in advance of when they are due, you lose the opportunity to invest those funds and potentially grow your capital. Will Changing Withholding Affect My Paycheck?Yes, changing your tax withholding will change your take-home pay, though your gross pay will not change. Increasing your tax withholding with reduce your net paycheck amount, while decreasing your withholding increases the amount you take home. How Do I Update My Withholding Amount?If your employer withholds taxes on your behalf, you can submit a revised Employee's Withholding Certificate (Form W-4). The Bottom LinePeople may go years without the need to significantly alter their withholding status. But when life changes do occur, it's worth taking the time to re-file the W-4. If you pay out too much to the government throughout the year, you will be refunded. But if you pay out too little, you may be surprised by a large bill. |