Have You Checked Your Tax Withholding Lately?

Can you believe there are less than 3 months left in the year?!?  The year seems to be accelerating to a close for us, probably because Becky and I have been so busy getting our house in order to prepare for our upcoming Gap Year!

Regardless of what your own plans are for the coming year, this is a good opportunity to check in on your federal tax withholding.  In other words, have to withheld enough money from your paychecks (or paid enough in quarterly tax payments for the self-employed) to cover what you owe in taxes?

Withholding too little means you could end up owing a significant amount in taxes when you file next year, plus you could be in for some surprise fees!  Withholding too much means you’ll end up with a tax refund when you file which could be a loss as well if you look at the opportunity cost of having access to that money earlier.

Below, I’ll cover how I went about checking in on our own withholding, the little surprise I came across, and why we don’t plan on adjusting it anyway!

How To Check Your Withholding

For anyone that gets the majority of their income from a steady paycheck, the best way I’ve found to check in on your current withholding and make any necessary adjustments is the official IRS withholding calculator:

Link to IRS Withholding Calculator

This webpage will walk you through a series of questions that are easy to answer if you have your latest paystub(s) in front of you.  Questions include:

  • Filing status for 2017
  • Number of Dependents
  • Expected Income
  • Expected contributions to tax-deferred retirement plans
  • Total Tax Withheld so far
  • Tax withheld on latest paycheck(s)
  • Estimated tax deductions

With Becky’s final paycheck and my most recent one in hand, the entire process took about 5 minutes from start to finish.  Of course, I think about our taxes and deductions on a semi-regular basis (doesn’t everyone?), so maybe give yourself an extra 5 if you need to look a few things up.

If you don’t withhold your federal taxes from your paycheck, you may have to do a bit more calculation manually.  Up until this point in the year, you should have already made multiple estimated tax payments, so hopefully you have a pretty good handle on how the process works.  Now is a good time to double-check everything is looking good through the end of the year.

If you’ve made money and haven’t withheld or paid any taxes yet this year, I would start researching ASAP!  Penalties can add up fast if you should have been making quarterly payments and haven’t.

Adjust If Necessary

Now that you’ve determined how much in taxes you’ve paid so far and how much more income you expect over the rest of the year, it’s time to make any adjustments if necessary.  If you used the IRS withholding calculator linked above, it will tell you exactly what to expect at tax time.  For example, I got to the finish and was told:

“If you do not change your current withholding arrangement, you will have […] withheld for 2017 leaving $5,630 due when you file your return.”

What!?! We’re going to owe $5,600! That’s a bit of a surprise, but I’ll explain how we plan to handle it further below.

Your own result may be completely different!  If you’ve already calculated your withholding earlier this year and adjusted your W-4 appropriately, then your result might come out within ~$100 or so in either direction of what you owe which is perfect.  If that’s the case you don’t need to make any adjustments at all and can pat yourself on the back for being ahead of the curve.

If your results says you’ll either owe something at tax time or will end up with a large refund, it’s time to look at your options:

If You’re Withholding Too Much

If you’ve withheld too much in federal taxes, then you will end up getting a big refund at the end of the year.  While this isn’t the end of the world, it leaves a lot of opportunity to optimize and actually profit off of adjusting downwards and getting access to that money earlier.  Remember, a tax refund isn’t free money!  It’s money that you accidentally loaned to the government that you have to file your taxes in order to get back.  It’s your money all along, so why not get it into your bank account much sooner?

I actually have already written an entire post on the opportunity cost of withholding too much, so I’ll just link to it instead of explaining it all again:

Link to How Much Did That Tax Refund Cost You?

In an extreme example, someone with outstanding credit card debt that expects to receive a large refund ($5,000) is costing themselves ~$900/year!

Don’t be that person.  Take the IRS calculator’s advice on lowering your withholding for the rest of the year and get access to that extra money in your next several paychecks instead of when you file your taxes some time next year.

If You’re Withholding Too Little

Like us, if your result says you’re going to have a hefty tax bill come tax time, it’s probably best to bump your withholding up and get it closer in line.  Depending on your current tax status and how much you paid last year, there may be a cost to doing nothing in the form of a tax penalty.

Imagine finding out that not only do you owe the IRS money, but you also have to pay them extra because you didn’t withhold enough during the year!  Luckily, there is still time to avoid that situation.

If you filled out the IRS calculator above, it will tell you exactly how to fill out a new W-4 in order to get your withholding back in line and avoid any penalties.  The information should look something like this (result of a sample input):

Based on your responses, your anticipated income tax for 2017 is $16,034. If you do not change your current withholding arrangement, you will have $9,600 withheld for 2017 leaving $6,434 due when you file your return. To meet your anticipated tax of $16,034 change your current withholding arrangement by claiming 0 allowances plus an additional amount of $6,622 for the balance of 2017. Here’s how:

  • You and your spouse should each enter 0 on line 5 of all of your Forms W-4.
  • Have $6,622 withheld over the balance of this year. You may split this amount between your jobs any way you choose, entering on Line 6 of each Form W-4 the additional amount to withhold per paycheck for that job. If you want to spread the additional withholding in proportion to what would otherwise be withheld, then enter the following amounts for the job shown:
    • Job 1 (which has a projected salary of $75,000): $521 per paycheck.
    • Job 2 (which has a projected salary of $80,000): $1,165 per paycheck.
  • Check the “Married” box on your Forms W-4

Assuming this recommendation is in effect for the rest of 2017 , your withholding will approximately equal your anticipated tax, and any refund or balance due should be less than $25.

Those bullet points at the end of the IRS calculator explain exactly how to fill out any and all W-4’s you need for the jobs entered in order to get your tax withholding back into line.

NOTE: Once you do this for the final few months of paychecks, your tax withholding will be artificially high compared to what you should have been withholding the entire year.  Be sure to run the calculator again (ideally the 2018 version) early next year to readjust them back into line.

Avoiding The Underpayment Penalty

If you do manage to end up owing money come tax time, there is a chance you won’t owe any penalties.  The 3 most common ways to avoid this penalty are:

  • Owing less than $1,000 in tax
  • Paying at least 90% of the current year’s tax (For example: If your total taxes are $30,000, you can underpay $3,000 without penalty)
  • Paying at least 100% of the prior year’s tax (Or 110% is you make $75k as a single filer or $150k as married filers)

In addition to these straightforward exceptions to the penalty, there are also special exemptions for natural disasters, unusual circumstances, or if a retirement/disability event happened during the year.  See here for more information.

With these exceptions in mind, it may be possible for someone that is organized to “game” the system a little bit and deliberately under-withhold in order to do something with the money owed in the meantime…

Our Own Plan

As I mentioned above, we’re in for a rather large tax bill ($5,600) come tax time if we don’t adjust our withholding.  The good news is that the main reason we under-withheld accidentally up until this point is that we ended up making a little more money this year than anticipated.  Talk about a good problem to have!

Related to that point is that we are making more in 2017 as a couple than we made in 2016, so we’ve already met the exemption for paying over 110% of our prior year’s tax and won’t be subject to any penalty.  So now we have two options:

  1. Adjust our withholding so we owe nothing when we file taxes
  2. Don’t adjust our withholding and keep the money set aside to pay the tax bill

For now, we’re going to take option #2 and just keep that money set aside in our high interest savings account.  Not only will we make the ~1% interest rate for the next ~6 months (a free ~$25!), but we should also be able to pay that tax bill using a credit card come tax time!  There will be a fee to do so, but that will be significantly outweighed by the value of whatever signup bonus we are going after at the time.

Even if we don’t have a new credit card at the time, paying with our 2.5% cash back everywhere card should at least yield a small profit!

Future Years

Obviously this plan only really works once unless we are growing our income a significant amount year over year, so normally we would need to make an adjustment early next year to start withholding the full amount we owe.  For us, next year will be anything but normal because we’re quitting our jobs to travel around the US for the entire year, so I won’t be worried about tax withholding again until we return.

Unless of course we make some unexpected money along the way, then I’ll have to investigate how much we should be making in quarterly estimated tax payments (if any).  That will be an exciting day if it ever comes to fruition!

 

Well, what are you waiting for?  Go check your withholding for the year and see if you need to make any adjustments!  I’ll wait here in the comments below if you run into anything interesting.


6 thoughts on “Have You Checked Your Tax Withholding Lately?

  1. It’s definitely important to check this. I know that the wisdom is that you shouldn’t get a tax refund, but with savings rates so low, I actually don’t have a problem if someone wants to have more deducted and get a bigger refund come April. Many people will spend it if it’s in their paycheck, but if they don’t see it, they won’t spend, and therefore would come out ahead, even with earning no interest.

    So that’s something to consider as well.

    1. In general, I don’t have any problem with people choosing to get a large refund IF they understand the trade-offs. The situation you describe usually has a much bigger problem of people not spending money consciously.

      If whatever amount of money ends up in a checking account gets spent and you have to “trick” yourself into not spending it by hiding or delaying it, you might have a spending problem. I know this method works for some, but a better victory would to just become comfortable with having a little cash around and sticking to a budget of some kind regardless of what your current checking account balance is.

      Unfortunately, I think a lot of people who do end up with a big refund don’t choose to invest it at all. They use it as an opportunity to upgrade their furniture or tv set if ads around that time are any indication. I imagine those same people might have some credit card debt which means that eventual refund could end up being very expensive. Baby steps, and adjusting withholding to something reasonable might be a good starting point.

  2. Good post. Have you thought about maximizing your exemptions to avoid any tax withholding during the year and investing that instead? And then paying a big tax bill come September (I think you have to still make quarterly estimated payments right?). I know some bloggers have talked about this, interested in your take.

    1. Hey JCB,

      I’ve considering manipulating my tax withholding in order to get some easy credit card spend, but I believe what you’re describing would come with penalties. You can’t just save up money and make one big tax payment down the road.

      As you mentioned, you have to at least make quarterly tax payments, typically in an even 1/4 of the year’s total expected tax every 3 months or so. If you fail to do this, the IRS will charge you penalties and interest. This makes the time horizon (~3 months) from when I would obtain the non-withheld funds before they were due. I could throw it in a high interest savings account, but that won’t yield much and probably isn’t worth the effort.

      I definitely wouldn’t invest in stocks over that short of a time frame, that’s just asking for trouble due to the volatility.

      More info on the credit card thing if you haven’t seen that post:
      http://moneymetagame.com/churning/guest-post-the-ultimate-credit-card-rewards-hack/

  3. Thanks for the reminder to check on this! After putting in my wife’s and my numbers, we are projected to be under-withheld by ~$40k by the end of the year, so this will help to get out in front of that and not get penalized.

    Much appreciated!

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