Picture this: It's payday and you casually glance at your paystub. Have you ever found yourself wondering about that chunk automatically deducted for taxes and how it might be affecting your financial potential? You're not alone. In the US, the majority of wage earners opt for the Pay-As-You-Earn (PAYE) tax system, where a portion of your income is withheld for taxes by your employer, based on the information you put on Form W-4 when you're hired.
It seems convenient, but what if things change over the course of a year? Well, there are some notable situations when recalibrating your tax withholding might be an advantageous move.
Any significant shifts in your familial or domestic circumstances can immediately influence the amount of tax you owe. For instance, the birth of a child, a change in job status by your spouse, or the purchase of a home could prompt a change in your withholding. It's all about avoiding paying more taxes than required.
Marriage too can affect your taxation. If both you and your spouse are income earners, your combined household withholding might need an upgrade. Conversely, if your spouse is jobless, your withholding would probably decrease. Sometimes, opting for separate filing can be beneficial.
Moreover, the aftermath of a divorce also holds taxing implications. The 2017 Tax Cuts and Jobs Act, effected changes in tax treatment of alimony such that, as of 2019, payers can’t write it off and recipients don’t have to declare it as income.
Adding a dependant to your family, by birth or adoption, translates to an immediate lightening of your overall tax burden. Hence, acquiring new dependants implies the readiness to scale back your withholding to optimise new credits and deductions efficiently.
Similarly, when a dependant moves out of the household or your children reach adulthood, it might be time to reevaluate and adjust your withholding.
Buying a home can bring a multitude of tax benefits, hence it’s worth updating your withholding in line with these benefits. This strategy can be applied for any large deduction or credit, including education credits, dependent care expenses, medical expenses, and charitable donations.
Non-wage income sources like side businesses, stock dividends, or interest require you to tweak your withholding. It's no different if you earn from selling stock or cryptocurrency for profit.
Households with dual income and those juggling multiple jobs are especially susceptible to withholding discrepancies. Generally, it's advisable to have a clear understanding of how income from various jobs could push you into a higher tax bracket and adjust tax withholding accordingly.
Use the IRS online Tax Withholding Estimator, along with Form W-4 instructions to correctly estimate your preferable withholding amount. Then contact your employer to initiate a revision of your federal income tax withholding.
Crucially, increasing your tax withholding will reduce your net pay, while a decrease provides a hike. By withholding more than necessary you might be inadvertently bypassing investment opportunities in order to avoid a tax bill.
It's true, adjusting your withholding might not be an annual need, but when life takes a turn, make it a point to revise your W-4 with an updated withholding amount. Remember, paying the government too much throughout the year is akin to giving them an interest-free loan, whereas underpaying can lead to a shocking tax bill.