With yet another tax season under way, it is time to evaluate your tax withholding and determine whether or not you should adjust it. There are a number of reasons to consider changing your tax withholding:
Major life changes might mean a necessary change in your withholding. Marriage, divorce, death of a dependent, and the birth of a child are all life changes that can result in a need to change the number of exemptions that you claim on your W-4. This change will mean a difference in your withholdings.
You Ended Up with a Big Refund
A big tax refund is a sign that you have been offering the government an interest-free loan. The government can even earn interest on money that is actually yours if your withholding are set too high. (Although in these times of high government debt, maybe you want to do your part to help out a little.) Unless you get substantial psychological and emotional benefits from having a big tax refund — or if you won’t save the money throughout the year so you can earn interest on it — it might be a good idea to adjust your withholding so that you have less being set aside for taxes and more in your paycheck.
You Owe Too Much in Taxes
One of the common bits of advice you will see around the personal finance blogosphere is to avoid a large tax return. And, while it’s better for you to be getting an interest free loan from the government than providing one, a large amount of money owed can be a problem. If your withholding is too low, and you owe more than $1,000 to the government, you may be subject to interest and other penalties. One notable exception to this is if you are self-employed and making quarterly payments. As long as you pay based on your income for the previous year, you should be able to avoid penalties.
Try to adjust your withholding so that you are close the break even point. The IRS has a handy withholding calculator to help you figure out an appropriate withholding. I went through it, though, and it’s not much help if you are self-employed, since it doesn’t take the self-employment tax totally in question. But it’s not bad overall.
How to Adjust Your Withholding
It’s fairly straightforward to adjust your federal tax withholding. All you need to do is fill out a new W-4. Your company’s human resources department should be able to help you. Change the number of withholding allowances on your W-4, and sign and date the paperwork. You should check your paycheck after the new W-4 is submitted, watching to ensure that your new withholding is reflected.
If you are decreasing the amount of money withheld for taxes so that you get a smaller refund and a bigger paycheck, you can decide to have it added to the amount you are setting aside for savings or for your retirement account contribution. This can be a good way to make sure that you are putting the money to work for you throughout the year.