It’s only been a few weeks since many people rushed to file their taxes before the tax deadline in April. Were you surprised this year at how much you got back from the government? Or did you end up paying a lot of extra tax instead of getting a refund?
Being on either end of the spectrum — massive refund or massive tax liability — isn’t a good place to be. No one wants to owe the government a ton of money, but letting Uncle Sam sit on thousands of dollars over a given year isn’t wise either. If you found yourself in either of these camps you need to look at adjusting your tax withholding with IRS Form W-4. This will help eliminate the gap between what you paid in tax and what you were supposed to pay.
How to Adjust Income Tax Withholding
Making adjustments to how much tax is taken out of your paychecks is an inexact science that involves tweaking the withholdings on your Form W-4. You can make these adjustments at any time during the year. You can also adjust your withholdings as many times as you want (or as often as your human resources department will put up with).
To change the amount of tax withheld, you can use the Personal Allowances Worksheet in the middle of the first page on Form W-4. (There is also a more detailed worksheet on the back that helps you figure in your deductions if you itemize your taxes, see form.) Calculate your allowances based on your current situation and be sure to carry that number down to Line 5 on the first page. Fill in the rest of your information and pass it on to your payroll or HR department, whichever handles the processing of W-4 forms.
Caution: Don’t Make Huge Adjustments
Calculating your personal allowances should help you get relatively close to even with the government. You might owe a little or get back a little on a refund. The goal is to avoid the huge refunds and huge tax liabilities.
However, don’t overreact if you ended up with a huge tax liability or refund this year. Tweaking your allowances and withholdings should be done incrementally. If you had 8 allowances last year, don’t drop it to 0 this year because you don’t know exactly what that would do to your paycheck. Take small steps and see how much extra tax is taken from your check (or isn’t, if you’re trying to reduce a massive refund). You’ll be more capable of adjusting to your new paycheck and monthly income with small steps than jumping in with both feet.
The IRS also has a very useful (albeit somewhat complicated) calculator that helps you adjust your withholdings for the rest of the year to avoid tax problems.
When to Adjust Your Tax Withholding
Including receiving a surprise — good or bad — when you file your taxes, are there other reasons to change your tax withholdings?
Huge Tax Liability
The most critical issue that requires a tax withholding change is a big tax liability. There is nothing worse than having the government inform you that you owe them a few thousand dollars. For many cash strapped families, this can be devastating.
Big Tax Refund
Some people prefer to get huge refunds because they use that money to pay down debt or take a trip. From a financial standpoint, you are better off having an extra $300 in your pocket every month than getting $3,600 back at tax time. You can save, invest, or pay down debt faster when you get the money each month. However, this does require financial discipline. (You’d be better off leaving things as they are if you would just blow that extra $300 every month.)
Significant Life Change
Getting married? Just have a new baby? Paying mortgage interest for the first time? All of these big life changes can significantly alter your tax liability. Recalculate your personal allowances each time a new life change happens.
Don’t Forget State Withholding, Too
It is easy to think of the Federal government as the only place you need to make tax changes with, but all of the above holds true for your state tax withholding as well. You could give yourself a big monthly income boost by cutting your tax refunds in half from both the Federal and state governments and getting the extra cash each month instead.