Tax withholding considerations

Your taxes keep the government running.

Imagine how hard it would be to manage your household if you were paid just once a year. The federal government would find itself in the same situation if you — and every taxpayer — paid your tax bill on the day you file your tax return. So to ensure a steady stream of income throughout the year, the government requires your employer to withhold a percentage of what you earn from each paycheck and deposit it with the government.

If you’re self-employed, or if you have income from investments or other sources, you must estimate the amount of tax you’ll owe for the year and pay it in quarterly installments.

Where withholding applies

The government requires withholding on many types of income, including tips and commissions, bonuses including retirement bonuses, and some retirement income including from pensions, annuities, tax-deferred employer savings plans, and traditional IRAs. What you may not realize, though, is that withholding also applies to certain job perks, such as a company car, as well as sick, vacation, and, in many cases, severance pay. Gambling winnings are also subject to withholding.

How withholding works

Your employer is responsible for withholding the tax you owe from your employment income, but you’re responsible for providing the information your employer uses to calculate the correct amount. You do that by filling out IRS Form W-4, which your employer will give when you start your job. Ideally the amount that’s withheld will equal what you owe when you figure out your tax bill, give or take a few dollars.

You report your filing status on the W-4 by choosing one of the five possible categories: single, married filing jointly, head of household, married filing separately, or qualifying widow(er). You can determine the correct status by referring to IRS Publication 17. If you are eligible to use more than one filing status, you should choose the one that results in your paying the lowest tax.

You also indicate the number of allowances you are claiming, usually based on the number of dependents you have. There may also be other factors, such as a second job or investment income, that will influence the amount of tax you’ll owe. You can estimate the number of allowances by using the worksheets that are part of the W-4. But you’ll find it also helps to have your most recent tax return and the stub of your most recent paycheck handy to help you get it right.

The IRS can charge you a penalty if you’ve had too little withheld, which the agency determines when you file your return. And there are more serious consequences if you knowingly provide false information to reduce your withholding.

Updating your W-4

Your employer probably won’t ask you to update your W-4 after you begin working, but will use your new information if you provide it.

It’s a good idea to review what you’re having withheld from time to time, especially if you owe a substantial amount when you file your return, or if you get a big refund. Any major changes in your life — having a baby, buying a new home, losing a dependent, receiving a major bonus — will affect your tax obligation.

The more allowances you claim, the smaller the amount that will be withheld. So if you’re in a situation that’s likely to decrease what you owe — filing as a head of household instead of as a single filer, paying interest on a mortgage loan and real estate taxes, or qualifying for childcare credits — you can increase the allowances you claim.

Or, if you have additional income from self-employment, your income is high enough to limit your deductions, or you have income from which nothing is withheld, you may want to decrease the number of allowances to increase what your employer withholds.

Estimated taxes

If you must pay estimated taxes, you use Form 1040-ES to calculate what you owe. That amount is due on a quarterly schedule, in April, June, September, and January of the following year. You can choose to pay off the entire amount at any time. But if you pay less than you owe in any quarter, you may owe a penalty, even if you pay the difference in a later quarter.

Unless your income for the year is fairly predictable, as it may be if you’re collecting Social Security or receive alimony, it’s probably wise to work with a tax advisor to be sure your calculations are correct. That’s good advice as well if you’re receiving unemployment or disability benefits.

A bad way to save

Some people increase their withholding to get a big refund in the spring. That’s money they plan to use to pay for a vacation or something else they might not be able to afford otherwise. But using withholding as a savings plan means you’re giving the government an interest-free loan. What you get back is what you put in. It’s rather like putting money under your mattress.

If you don’t trust yourself to save regularly on your own, ask your employer to deposit a percentage of each paycheck in a savings or investment account you’ve opened. You could also arrange a regular transfer of funds from your checking account, in a set amount that you choose, to your investment account.




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