Every so often, it pays to update your tax withholding code to avoid owing a big tax bill at year’s end. Otherwise, you are essentially loaning the government your hard-earned money at zero interest. Especially if you’ve gotten married or had a baby in the last year, consider updating your information with the IRS today.
What is Tax Withholding?
In each paycheck, your employee likely withholds taxes that are paid to the IRS. This tax withholding is based on the amount you earn and the information you provide on your Form W-4.
Withholding is calculated according to three basic pieces of information:
- Marriage status
- Allowances for which you qualify
- Whether or not you want to withhold extra
When Your Life Changes, Your Tax Withholding Should, Too
A monumental life event can result in major life changes. But with all the excitement, don’t forget to update your tax withholding code when preparing your individual taxes. Updating your Form W-4 today could save you big money.
Walking down the aisle with someone changes a lot, including your tax return. After returning from your honeymoon, the time is right to change your tax withholding code. If your spouse has an income stream, your overall household withholding may rise. Conversely, if your spouse does not work, your overall withholding may decrease.
After a divorce, it makes sense to change your withholding code, because your household income will most likely decrease. A spouse that pays alimony can adjust their withholding by filing a new form. A spouse that receives alimony must pay tax on that money and file a new form as well.
When a new child enters the family, household expenses likely will rise. Fortunately, by claiming a dependent on your Form W-4, your take home income increases. This break is good for both natural birth and adoption.
After purchasing a new home, you would benefit from updating your withholding code to make the most of the expected tax break. Technically, you don’t have to change your withholdings until the end of the year. But, if you want more money in your pocket now, the earlier the better.
As a rule of thumb, when your income goes up, your tax liability will likely increase as well. A new second job calls for a new W-4. A side benefit of holding two jobs is that you can split allowances between your two separate paychecks.
Taxpayers should remain vigilant every year in reporting outside income to the IRS. If there is a spike in income from sources other than your day job, you will need to withhold more money or start paying estimated taxes to avoid owing the government a large sum of money.
The unemployed often overpay in taxes because they had too much yearly tax withheld. If you are re-hired in the same year, you’ll want to adjust your withholding for the time out of work. You should decrease allowances on a new W-4 to avoid overpayment of taxes.