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How Your Payroll Tax Withholding Can Cause Tax Debt

You can get in over your head in tax debt if you don’t withhold the right amount from your paychecks.

tax withholding

You already know taxes get taken out of every paycheck you earn — we all feel that painful difference between gross pay and take-home pay.

But did you know the way taxes are taken out can affect whether you get a refund or owe money? Did you know you can control that amount?

Large tax refunds are a sign your payroll tax withholding is set too high

If too much tax is being withheld from your paycheck, you end up getting a refund. While everybody likes suddenly getting a pile of money, this is actually a bad thing.

It means you’ve been giving Uncle Sam an interest-free loan, rather than getting that extra money in every paycheck where it could help on a day-to-day basis. It could be used to pay off debt sooner and cheaper, or invested to earn interest. Investing the extra money you do not need to spend in tax-deferred savings plans such as IRAs can also help reduce your overall tax bill on your annual tax return!

On the other hand, when too little tax is withheld, you end up owing the federal government money. This sucks for the obvious reasons: It’s another bill, and one you probably didn’t expect. If you repeatedly under-withhold tax on your checks and accrue tax debt with the IRS, they can send a “lock-in” letter to your employer forcing you to withhold at the highest tax rate. That takes away all of your flexibility when it comes to paying your current taxes!

If you do find yourself owing more in tax than you can afford to pay back, you do have options. It is always a good idea to seek professional help anytime you feel in over your head or if you just want to make sure you end up with the best possible outcome to an already bad situation.

The ideal situation is to owe nothing or get a tiny refund, and you do that by changing your tax withholding. That way you can take control of your funds and make the best decisions for you and your family on how to spend it. But first, you need to know when to do that.

If you would like to consult with a tax debt professional for free, let Debt.com connect you with the right expert for your needs.

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When you should change your tax withholding

The first clue that your tax withholding is wrong is the total line on last year’s return. The bigger the number, whether positive or negative, the more likely a change is in order.

But there’s a whole slew of situations that could have changed your tax liability since then, including:

  • You were unemployed or self-employed for part of the year
  • You had multiple jobs
  • Your working spouse changed jobs
  • You got married or divorced
  • You had a baby
  • Your son or daughter started filing their own taxes
  • You had income from outside your job, such as interest, dividends, alimony, or unemployment benefits

Basically, you should revisit your W-4 — the form that specifies your tax withholding — after any major change in your life.

How to change your payroll tax withholding

You can file a new W-4 with your employer at any time. Like nearly everything tax, the W-4 form can be tricky to complete correctly! You will also need to coordinate with your spouse if you are married, as not to overclaim household exemptions.

To complete Form W-4 successfully, think in terms of your tax return and not in terms of real life. For example, consider your filing status and not just your marital status. If you and your spouse file jointly, select “Married” on your W-4 but if your file separately, select “Married, but withhold at a higher Single rate”. Choosing the wrong marital status will get you off to a bad start from the beginning. Also keep in mind that you aren’t going to claim someone on your tax return as a dependent, don’t figure them into your W-4 either!

Another good tip is to take advantage of all possible tax exemptions on your W-4 for your main job. That’s the job that pays the most money to you. If you have multiple jobs, your secondary, lower paying jobs’ W-4s should be completed with 0 exemptions and taxed at the highest tax rate. This will prevent any unexpected tax bills come filing time!

The IRS has a withholding calculator to help you find the right balance. This tool is an excellent resource to use while completing your W-4.  To get the most accurate results, you’ll want to have recent pay stubs and your last tax return on hand.

Check your withholding now before the end of 2018!

If you haven’t done so already since the new tax reform laws took effect this year, Debt.com recommends that you should check your withholding now. There is still time before the end of the year to make adjustments if you see that you’re going to owe something when you file next year.

If you increase your payroll tax withholding now, you can make up the difference, so you don’t have tax debt next April.

Don’t leave your taxes to chance! Let Debt.com connect you with the right professionals so you can avoid a bill next year to Uncle Sam!

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Article last modified on November 29, 2018. Published by Debt.com, LLC . Mobile users may also access the AMP Version: How Your Payroll Tax Withholding Can Cause Tax Debt - AMP.