May is a great month for so many reasons – beautiful weather, the kickoff of summer and best of all 11 more months before we have to file taxes again! As sure as May is to bring us reasons to smile, April can be a little more moody. Rain and persistent cold can pop up out of nowhere and filing our tax returns can often lead to a surprise tax bill we weren’t anticipating.
It’s easy to neglect our tax withholding. Our lives are busy and many of us assume that our employers are withholding the right amount of taxes for us. We definitely know they’ve taken something out before the money hits our bank accounts! But things like having multiple wage earners, unusual itemized deductions or sizable income from your portfolio can render your wage withholding insufficient. Nobody likes a surprise bill at the end of the year (or the end of a meal as Jerry Seinfeld quips in this bit), so how do we avoid it?
What’s the Goal?
Some folks like to get tax refunds; others don’t want to give an extra nickel to the government for any longer than they have to. There’s no wrong answer, but our approach is typically to aim for the filing of your taxes to be a non-event, meaning you neither owe money nor get a large refund.
Calculating the Shortfall or Surplus
The first step is getting a reasonable estimate of how much tax is due on your income. The IRS’ withholding calculator is a good tool to help you do that. It takes you step by step through the relevant information you need to enter. To make best use of it, you’ll need last year’s tax return and your most recent paystubs. You can find info about your filing status, deductions and credits on the first two pages of last year’s return. When asked about your withholding year-to-date, look at your most recent paystubs. The code ‘FITWH’ stands for federal income tax withholding. Next you’ll need to enter in the itemized deductions you had from last year, all of which can be found on Schedule A of your tax return. Absent a change like moving to a new home, incurring significant medical expense or upping your charitable giving the itemized deductions from last year should give you a reasonable estimate of what they’ll be like for this year as well. Once you’ve entered this information, the IRS will estimate your tax due for this year and tell you whether you are withholding more or less than is needed.
Executing the Changes
If you find that you’re paying in too much or too little, you can adjust your payments. If employed, you can change withholding elections through your employer. Employers with either ask you to complete a new Form W-4 or they will take written or verbal instructions for how to adjust your withholding.
On the W-4, you’ll have to choose how many exemptions you want to claim. You can claim as many or as few as you’d like from as low as 0 to as high as 10. If you are trying to increase how much is withheld each check, reduce your exemptions and vice versa.
The tricky part about changing your exemptions is you don’t know exactly how your withholding will change until your next paycheck. To narrow it down, you can look at the federal income withholding tables starting on page 44 of IRS Publication 15. Find the table that matches your marital status and paycheck frequency, then find the amount of your paycheck. Next to it will be the amount of withholding for each exemption 0 through 10.
Because exemptions can be tough to deal with, an alternative is to leave your exemptions unchanged and increase your withholding by a specific dollar amount. Let’s say you need to pay another $5,000 between now and the end of the year. If you’ll get 12 more paychecks by year end, you’ll want to increase your withholding by $417 per paycheck. Once notified, your employer can increase your withholding by exactly that amount.
This may sound like a taxing process, but being intentional about your tax payments not only reduces stress of the unknown, it helps you to avoid underpayment penalties and better manage your cash flow. Give this a try or reach out to us or your CPA for help. With 2015 taxes now behind us, now is a great time to make sure you are on track with your 2016 tax payments so you don’t wind up with unwelcome surprise next spring.
Have a wonderful week and happy Memorial Day!