Achieve Balance with Federal Tax Withholding
Federal tax withholding can be a delicate balancing act. You should aim to have just enough withheld to cover your tax obligation, but it’s okay if your annual withholdings don’t exactly align with your tax bill. It’s alright if you have a bit too much withheld and end up receiving a small refund, or if your withholdings fall a little short and you owe a small amount when you file your tax return. The point is to get as close as you can to having the correct amount of taxes withheld so you can retain control of your money during the year, and avoid a large tax bill and unnecessary penalties when you file your taxes.
How Much Will I Owe?
A good place to start, when trying to determine the correct amount to withhold, is your last tax return. Did you receive a large refund, or owe a significant balance that was either hard to pay or subject to a penalty? If so, you probably need to adjust your withholding amount. The IRS has a digital Tax Withholding Estimator that you can use to help determine if you are currently having enough, or too much, withheld. If you find that your withholdings are insufficient or excessive, you can change your withholding amount by filling out a new W-4 form and returning it to your employer.
Updating Your W-4 Form
Prior to 2020, the W-4 form relied heavily on “withholding allowances” to determine how much to withhold from an employee’s paycheck for federal taxes. However, the W-4 form was updated in 2020 to better align with new tax laws, and allowances were removed completely. You can access the new W-4 form, as well as a list of frequently asked questions about it, at https://www.irs.gov/newsroom/faqs-on-the-2020-form-w-4. Accurately filling out the form should bring you very close to where you need to be from a withholding perspective.
The new W-4 form also includes an optional line for “extra withholding” where you can specify a dollar amount you want your employer to withhold, beyond what they would deduct based on the other information provided. This could be helpful if you are making changes to your W-4 mid-year and are afraid that your prior withholdings weren’t sufficient.
Review Your Withholdings Often
Remember that your W-4 form isn’t a “set it and forget it” thing. There are several factors that can impact your tax bill and could warrant changes to your withholding amount. Common situations that could affect how much tax you owe include:
- Changes to your unearned income, like money received from interest, dividends, unemployment compensation, alimony, or capital gains from the sale of real estate
- Lifestyle changes such as having or adopting a child, getting married or divorced, or purchasing a new home
- Job-related changes such as retiring, going from part-time to full-time employment (or vice versa), getting a second job, getting laid off or furloughed, becoming unemployed, getting a pay increase, or experiencing a pay cut
- Changes to tax laws