Did you discover when you filed your taxes, either earlier this year or this week to get in under the Oct. 15 extended deadline, that you were due a refund? Or, yikes, that you owed Uncle Sam?
Either way, now is a good time to review your tax withholding. With 2021’s third quarter just under way, you have plenty of time to deal with the differences either way.
And there is enough time left in the year to spread the changes over several pay periods so they don’t produce a major shock either way to your budget.
Rationalizing over-withholding: Around 70 percent of taxpayers every year choose to use the unofficial bank of the Internal Revenue Service as a savings account. They over-withhold their payroll income taxes so that they will get refund when they file.
This year, the average refund has been more than $2,700.
That over-withheld tax money doesn’t earn any interest, but those taxpayers don’t care. Banks are paying literally pennies a month on their savings accounts, so they’re not losing that much.
Plus, having the U.S. Treasury hold onto their money also is welcome, as it means they can’t get to it to make frivolous purchases.
But neither can they get to it in an emergency.
And the IRS’ delays this year in delivering refunds, some as far back as from the 2019 tax year, underscore the flaw in letting the feds hold your funds.
Changing withholding when it’s too much: By adjusting your withholding so that the final amount is as close as possible to the amount of tax you owe, you’ll have your hard-earning money in your hands year-round.
You can put it in a savings account where it earns at least a tiny bit of interest.
More importantly, you can access that account, for example, when your car breaks down or your kiddo breaks an arm and you haven’t met your health insurance’s deductible.
If you’re afraid you’ll just blow any added money in your paychecks, consider making your new savings account a direct deposit one. Most payroll offices work with financial institutions to set up automatic payments to such accounts.
Changing withholding when it’s not enough: Most folks change their withholding amounts after they’ve had to deal with a big tax bill at filing time. This happens when you don’t have enough withheld from each paycheck.
In this case, you’ll have to come up with the cash by the annual filing deadline. That’s usually April 15, but the due date has been delayed the last couple of years due to COVID-19 pandemic considerations.
Whenever the tax return and owed money is due, the IRS doesn’t mess around. While Uncle Sam doesn’t pay interest on your cash when you let him hang onto it, he does start charging interest and penalties if you don’t pay by the filing deadline.
That’s true even when you get an extension to file. The extra time is just to finish filling out forms. You have to pay what you owe, or a close approximation thereof, by the annual Tax Day deadline.
By adjusting your withholding either way so that the amount is as close as possible to your final tax liability, you won’t have to worry at tax time. No big payment to come up with when you send in your 1040. No waiting months (and months and months) for your refund.
Life changes mean changing withholding: If your withholding has been pretty much on the mark, you might be tempted to stop reading. Please don’t.
If you experienced some life changes, you also need to take a look at your withholding. Getting married, divorced, and welcoming a new bundle of joy into your family could mean changes to what you owe.
Major disasters also could affect your tax situation. Millions across the United States have endured wildfires, hurricanes, tornadoes, floods, and more this year. Special tax law provisions, such as claiming disaster-related losses, can help affected taxpayers and businesses recover. It also can change their ultimate tax bills.
So can coronavirus-related work changes. If you took on side gigs to make up for reduced hours or decided to go into business yourself after a layoff or you decided to quit, you’ll need to deal with estimated taxes, the self-employment version of salary withholding.
If you don’t pay the proper estimated tax amounts and don’t do so on time, you’ll be hit with those hated penalties and interest.
Figuring your appropriate withholding: OK, you’ve decided you do need to tweak your withholding at work. But by how much?
The easiest way to determine your proper withholding is to use the IRS’ online Tax Withholding Estimator, available in English and Spanish. Then just let your payroll office know the changes you want to make.
You don’t have to have a salaried job to use the withholding estimator. The online calculator also can help self-employed individuals and even retirees determine how much they need pay via estimated taxes or have withheld from pension payments.
The bottom line in all these cases is to be like Goldilocks as you pay the taxes you owe during the year on the money as you earn it. Not too much. Not too little. Just right.
You also might find these items of interest:
- 5 tax tips for freelancers, gig economy workers
- Tracking down tax records to file a disaster claim
- Oct. 15 also the deadline for foreign account FBAR filings
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