If this is your first tax season as husband and wife, here are four things that will be different this time...
4 Minute ReadTopic: taxes
Are you tired of sending the IRS a big check every year? Or were you surprised by how much you owed in taxes this year? It might be time to adjust your tax withholdings.
Tax Withholdings Explained
Before we dig into the details, let’s get one thing straight. Your tax obligation is your tax obligation. While a tax pro can help you maximize your deductions and credits, you can’t change what you owe the IRS.
Withholdings are simply the chunk of money your employer sets aside from each paycheck to cover your taxes. Withhold too much, and you get a tax refund. Withhold too little, and the IRS sends you a bill.
Two factors determine how much tax is withheld from your paycheck:
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- How much you earn each pay period
- The information you enter on your W-4 form
Dave recommends adjusting your withholdings so you break even at tax time. In other words, you don’t send the IRS a big check, and you don’t get a huge refund back either. That way, you can make the most of your money with every paycheck.
Related: Check out Episode #23 of Chris Hogan's Retire Inspired Podcast to hear more about Why Your Tax Return Isn't a Bonus.
Ready to get your tax withholdings back on track? Here’s how.
Step 1: Total Up Your Tax Withholdings
Let’s start by adding up your expected tax withholdings for the year. You can find the amount of federal income tax withheld on your paycheck stub. Let’s say you have $150 withheld each pay period and get paid twice a month. That would be $3,600 in taxes withheld each year.
If you’re married filing jointly and both of you work, calculate your spouse’s tax withholdings too. In this example, we’ll assume your spouse has $400 withheld each pay period and receives a monthly paycheck.
Then add the two together to get your total household tax withholdings.
Step 2: Estimate Your Tax Liability
Now that you know your projected withholdings, the next step is to estimate how much you’ll owe in taxes for this year.
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The IRS provides worksheets and a calculator to walk you through the process, which is basically like completing a pretend tax return. Keep your latest tax return handy and clear plenty of space on the table to spread out all the paperwork. If you itemize deductions or claim a bunch of tax credits, you’ll do lots of cross-referencing between various IRS documents.
Remember, federal taxes aren’t automatically deducted from self-employment income. If you have a side business or do freelance work, it’s especially important to factor that income into your tax equation.
Step 3: Subtract the Difference
Once you have an idea of how much you owe the IRS, it’s time to compare that amount to your total withholdings. Take your annual tax withholdings and subtract your estimated tax liability.
Let’s continue our example from above and assume your estimated tax liability is $9,600. In that case, you’d have a potential $1,200 deficit.
A positive balance indicates a refund, while a negative balance means you owe more and may have to pay the IRS interest and a penalty at tax time. The good news is you can fix it before tax time ever rolls around!
Step 4: Adjust Your Withholdings
If you run the numbers and find you’ve got ground to make up, it’s best to adjust your tax withholdings as quickly as you can. The longer you wait, the harder it will be to get it just right. You have two options:
- Reduce personal allowances. One way to increase your withholdings is to reduce the number of allowances you claim on your W-4. Fewer allowances means more tax will be withheld—though it’s by no means an exact science.
- Specify additional withholdings. If you don’t want to mess with your allowances, your other option is to enter an additional amount you want to have withheld with each paycheck. Simply divide your estimated tax shortage by the number of pay periods you have left before the end of the year to get your number.
If you get stuck along the way or don’t feel comfortable with your numbers, ask a tax advisor for help. They can make sense of your personal tax situation and guide you toward a reasonable target. With a few minor adjustments, you can strike a better balance and look toward next year’s tax season with a lot less stress.