How and why to adjust your IRS tax withholding

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If you owed money at tax time last season or, conversely, if you received a big tax refund, it’s a good idea to adjust your IRS tax withholding.

Why? In the first scenario, you don’t want to find yourself owing Uncle Sam money again. And while getting a refund is better than owing tax, you likely could use your earnings to pay for expenses during the course of the year rather than give Uncle Sam an interest-free loan.

To help you calculate the amount of tax you should have withheld by your employer, the IRS in January introduced a new Form W-4, Employee’s Withholding Certificate. It’s the first change to the form since 1987.

How tax withholding works

The IRS requires employers to withhold a portion of each worker’s paycheck for federal taxes throughout the year. Without this built-in, pay-as-you-go mechanism in place, chances are high that much of the American population wouldn’t be able to fork over the funds to cover their tax bill in mid-April, or even in mid-October if they were to file late.

Adjusting your tax withholding on Form W-4 has always seemed complicated. In previous years the form required you to make decisions about the number of your “withholding allowances.” These allowances were tied to the number of personal exemptions (i.e., dependents) that you claimed on your tax return. Generally, the more allowances you claimed, the less money would be withheld for federal taxes, resulting in a bigger paycheck.

But the Tax Cuts and Jobs Act did away with personal exemptions, so the IRS had to improvise. Instead of basing withholding on an employee’s allowances and marital status, it is now based on your filing status and the standard deduction for the year. If you itemize deductions, the new W-4 form does account for that as well as number of dependents, household income, tax deductions and tax credits.

“The new design reduces the form’s complexity and increases the transparency and accuracy of the withholding system,” claims the IRS on its website.

But veteran tax return preparers see it differently. “For all the simplification, it is definitely more complex for anybody who is more than just a W-2 wage earner taking the standard deduction,” says Judy O’Connor of O’Connor & Rodriguez, PA in Miami Shores, Florida. “They require you to figure out what your tax liability is going to be and back it into this form.”

Her partner Steven Rodriguez strongly recommends getting acquainted with the IRS’ Tax Withholding Estimator to help you come up with a more accurate estimate of your tax obligation for the year. “It’s worth the 10 to 15 minutes of your time to use it,” he says, “but be sure to have a copy of your most current tax return handy because the new Form W-4 asks detailed questions based on your current and prospective tax return,” including specific line items.

You will also need information about your spouse’s income, if applicable, and any other sources of income that you may have. There’s no threat to privacy when using the tool since you do not have to disclose any personal information, such as your name, Social Security number or bank account numbers, and the IRS does not retain any information you enter.

When you should adjust your tax withholding

If you’re just starting a new job, you will be forced to fill out the new Form W-4. If your old W-4 is on file with your current employer, you don’t have to make any changes if you’re satisfied with how the withholding worked out last tax season. But if too much or not enough was withheld, filling out a new form is warranted.

It’s also a good time to fill out a new W-4 form when you experience major life events, such as if:

  • Your filing status changes – in the event of marriage, divorce or widowhood.
  • You have or adopt a child.
  • Your child turns 17 in a given tax year.
  • You buy a home.
  • Your income drops dramatically.
  • You take part in the gig economy or get a second job.
  • Your spouse gets a new job.
  • You’re unemployed for part of the year.
  • You’ve paid off student loans.

How to adjust your tax withholding

If you’re single with just one job, no dependents and you take the standard deduction, then the new form is easy to manage. You just have to fill out the top part with your name, address, Social Security number and filing status. Then skip Steps 2-4 and provide your signature and date on the bottom of the form.

If you’re married and both you and your spouse are employed and make about the same amount of money, you might be able to get away with doing the same as above plus checking the box in Step 2(c). Each spouse would have to do this on their respective Form W-4. If one spouse earns considerably more money than the other, then too much tax may be withheld.

If you earn income from several sources or have dependents, it gets more complicated. Step 2 requires you to choose one of three ways to account for the various income sources:

  1. Use the IRS’ online tool for best results.
  2. Fill out the Multiple Jobs Worksheet on page 3 of the form.
  3. Take the shortcut described earlier for two-income households with similar pay.

Step 3 takes into consideration tax credits you get when you claim dependents. Here you can also factor in education tax credits and the foreign tax credit, if you’re willing to get into the weeds of the instructions.

Step 4 accounts for deductions and unearned income, such as from interest, dividends and Social Security. A deductions worksheet for Step 4(b) on the form factors in itemized deductions, including mortgage interest, charitable contributions, medical expenses and state and local taxes. If you are taking the standard deduction, you can add such deductions as student loan interest and deductible IRA contributions on the worksheet. However, do not add the actual standard deduction amount to the total as this will result in an error.

If you have another job and you don’t want to share this fact with your employer, you can use the online tool to calculate your projected tax liability and then put an “extra withholding” amount in Step 4(c). This won’t raise suspicions since, as far as your boss is concerned, you might want to do that anyway simply to get a bigger tax refund.

If you didn’t owe tax last year and won’t owe tax this year because you expect to earn less than the standard deduction amount for your filing status, then you can simply fill out the top part of the form and write “exempt” in the space below line 4(c) and sign and date the form. This exercise will need to be repeated each year, as the exemption status is good for one year only.