The federal income tax is a pay-as-you-go system. Taxes can be paid through payroll withholding or through estimated tax payments. When too much is withheld, the government holds the funds until tax filing and then returns the overpayment. The result is that the government receives a short-term tax-free loan. Most experts would argue that the taxpayer would be better served by closely matching their withholdings to the actual amount owed. With this option, the funds are available to invest or spend as they see fit. By reviewing your W-4 regularly and adjusting withholdings as needed, taxpayers can better manage their cash flow, which could provide increased monthly take home pay. In addition, it can help avoid unexpected taxes due and penalties for underpayment.
If you have experienced a significant life change, now is the perfect time to evaluate your withholdings. Keep in mind that some life events result in more taxes, while others entitle you to credits and deductions that lower your taxes. A few of the most common events that would warrant are review are:
- Starting a new job- Any significant change of household income, whether up or down, could have an effect on your tax bracket and require a modification of allowances.
- Getting married or divorced- These two events could change your filing status and alter tax liabilities. Coordination of benefits between spouses can also be reviewed at this time.
- Having a baby or adopting a child- This event brings an additional dependent allowance and may qualify the taxpayer to claim the child tax credit, child care tax credit, or the adoption credit. It may be beneficial to adjust withholdings to account for the added tax benefits.
For guidance on specific withholding situations, please visit the withholding calculator at http://www.irs.gov.