How and why to adjust your IRS tax withholding

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The IRS wants its share of your paycheck as you earn it, but you can influence the amount withheld by filling out Form W-4, Employee’s Withholding Certificate. You can do this at any time of the year.

The goal is to have just the right amount withheld – as close as possible to your actual tax liability. To have excess funds withheld may get you a big tax refund, but understand that you’re giving Uncle Sam an interest-free loan at a time when you could use your income for other, more constructive, purposes.

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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 have the funds to cover their tax bill in mid-April, or even in mid-October if they were to file late.

Form W-4 recently underwent a redesign to correspond with changes in tax law, courtesy of the Tax Cuts and Jobs Act of 2017. Currently, tax withholding is based on your filing status and the standard deduction for the year. If you itemize deductions, Form W-4 accounts for that, as well as number of dependents, household income, tax deductions and tax credits.

Steven Rodriguez, a partner at O’Connor & Rodriguez, PA in Miami Shores, Florida, recommends getting acquainted with the IRS’ Tax Withholding Estimator to help you come up with an accurate estimate of your tax obligation for the year. “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, he says.

The IRS provides FAQs for taxpayers with questions about its tax withholding estimator, as well as FAQs on Form W-4.

You will also need information about your spouse’s income, if applicable, and any other sources of income 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 have 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 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. For example:

  • 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 (Step 1) 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 (Step 5).

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:

  • Use the IRS’online tool for best results.
  • Fill out the Multiple Jobs Worksheet on page 3 of the form.
  • 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.

Written by
Barbara Whelehan
Contributing writer
Barbara Whelehan is a contributing writer for Bankrate. Barbara writes about a range of subjects, including homebuying, real estate, retirement, taxes and banking.
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