Get a jump start on tax season by checking your tax withholding amounts now.
Only two things in life are certain: death and taxes
Like the old adage says, taxes are one of the few certainties in life. If you’re like most people, you typically don’t think much about taxes until April 15 rolls around and tax returns are due for the previous year.
If you’ve had any income at all – earned income from a job; profit or distributions from a business you own; dividends or interest; or capital gains from the sale of an asset – that income may be subject to federal income taxes.
Depending on your state, you also may owe state income taxes, but that’s a subject for another day.
When you file taxes, you’ll either owe more or get a refund. While it may feel like a surprise bonus to receive a refund, that’s really money that belonged to you all along. And on the flip side, it’s pretty miserable to suddenly find out you owe even more taxes than you already paid.
Tax Withholding – what is it?
When you earn income, you have to pay income taxes. Income taxes can be “withheld” from the income before it reaches your bank account so that the federal government receives a portion each time you get paid. This is called tax withholding.
If you are employed, your employer typically withholds taxes from every paycheck before the net amount reaches your bank account. If you’re self employed, this tax withholding occurs through your paychecks or through quarterly tax payments. If you’re retired and living on a pension or social security, taxes can be withheld from these payments too.
What happens if the taxes being withheld are not enough, or too much?
The IRS form W-4 is used to notify your employer of the amount of income taxes you’d like withheld.
If taxes are not being withheld at the correct amount from your income, then that means you will owe more taxes or get a refund when you file taxes for the year. Sometimes tax withholding can be incorrect due to a change in your situation, such as:
- change in your family situation (divorce, marriage, death, or birth of a dependent)
- significant fall in your income, such as losing a job
- significant rise in your income, such as getting a raise or withdrawing more from your IRA account in retirement than you originally planned
How can I check my tax withholding?
Want to check whether you’re withholding the correct amount from your income?
If nothing significant has changed in your situation compared to last year, take a look at last year’s tax return to see the total amount you owed in taxes. Compare that to how much has already been withheld from your income, adjusted for how many months we have remaining in the year. If these two amounts vary significantly, do more investigating.
If you don’t know how much has already been withheld from your pay, check with your employer’s human resources contact.
Ask your tax professional to evaluate your tax withholding, and to provide a projection for how much you may owe in taxes for this year based on your personal situation. You’ll need to provide them with documentation like a recent paystub that shows the year to date total taxes withheld and income earned.
The IRS provides a tax withholding estimator which you can use to evaluate how much you’re withholding from your income. It also prepares a revised W-4 based on information you submit to the estimator. NOTE: This is not tax advice. Check with your tax professional on your personal situation.
Towards the end of the year, you have the benefit of more accurately being able to estimate how much income you will have for the year. This information is helpful when it comes to evaluating tax withholding because if you owe significantly more, or less, than what you have withheld, you’ll have a few months to prepare for the change in circumstances. Personal tax returns for the year are generally due April 15 of the following year, so you still have some time to accumulate the needed cash to pay taxes if you owe more.
Business Owners, Beware
Business owners may have a particularly challenging time evaluating how much to withhold in taxes. Business owners whose business files as an s-corp have two income streams from the business: payroll, and owner distributions. Payroll can operate just like a standard salary with a W-2 employee, but owner distributions tend to vary based on the business profitability. Business owners will owe taxes on both the payroll and the distributions if their business elects s-corp filing status. Business owners should complete a profit and loss projection through the end of the year and work with their business accountants to evaluate whether tax withholding has been appropriate.