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.
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?
Fact: In 2014, more than 98 million people received a tax refund averaging $2,694. Opinion: They’re dumb.
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 you money.
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.
The ideal situation is to owe nothing or get a tiny refund, and you do that by changing your tax withholding. But first you have to know when to do that.
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 are 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, or 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. You can file a new W-4 with your employer at any time.
The IRS has a withholding calculator to help you find the right balance. To get the most accurate results, you’ll want to have recent pay stubs and your last tax return on hand.