Thursday, February 8, 2018

Tax Time is a Good Time to Review Your Tax Withholding

Income tax liability, the amount that someone owes, is based on taxable income, deductions, exemptions, and credits.  A small refund, say $500 or less, is fine, but if you’re getting back a lot more, you’re losing foregone interest on money that could have been saved.  You also run the risk of having to wait for a large sum if you are an identity theft victim.

The amount of the income tax withholding is based on the number of allowances that a person notes on a W-4 form filed with their employer or quarterly estimated taxes sent to the IRS (if self-employed). If income taxes are over-withheld, a paycheck is smaller, and a tax refund is larger.  In simple terms, tax withholding can be explained this way:

  • More  withholding =  Smaller paycheck = Bigger tax refund
  • Less withholding = Larger paycheck = Smaller tax refund or additional taxes owed to the IRS
    The Employee’s Withholding Allowance Certificate section on the bottom of a W-4 form tells employers how much tax to withhold based on a formula from the IRS.  Anyone can change their W-4 form at any time with their employer and undo their over-withholding. Just be careful not to overdo it.
    Essentially, taxpayers must pay 90% of their current year tax liability to avoid a penalty plus interest.  However, there is a “safe harbor” exception : no penalties are due if a taxpayer paid at least 100% of their prior year’s tax bill (i.e.,  tax due on their prior year’s tax return) or 110% of the prior year’s tax if adjusted gross income (AGI) was more than $150,000.
    The Tax Cuts and Jobs Act of 2017 changed the IRS withholding tables used by employers. To determine if your personal tax withholding is still accurate, follow this three-step process:

  1. Do a calculation of the new tax law impact on your tax liability using an online calculator.
  2. Determine the tax withholding change in your first paycheck after withholding changes take effect and multiply that number by the number of remaining paychecks in 2018,
  3. Compare the results of steps 1 and 2 and adjust your W-4 form, if needed, to align the numbers better.

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