During the year many people have personal and financial life changing events that can affect how much they pay in taxes. But they often forget to adjust their income or paycheck tax withholding to cater for these events. This means they ending up owing taxes and associated penalties when filing; or missing out on extra money in their pockets during the year because they withhold too much in taxes. So if you encounter one of the following events, submit an updated form W4 to your employer’s payroll department to ensure you are withholding just the right amount of taxes.
Lifestyle changes – These changes probably have the largest impact on your tax obligations and includes the following events
- Birth or adoption of a child
- Purchase of a new home
- Chapter 11, bankruptcy
Each of these events can significantly change your tax filing status (single to married or vice-versa) and affect how many allowances and deductions you can claim for yourself and dependents. So make sure you revisit your tax withholding choices and financial plan any time one of these major life events occurs.
Employment income – If you, your spouse or dependents gets or loses a job then your paycheck withholding should be adjusted to account for the increased or decreased income. Even if you start a part-time job or side business you need to ensure that you are withholding sufficient taxes, or face a stiff payment and penalty when you file your taxes.
Changes in taxable income not subject to withholding – This is one category that gets a lot of people because it relates to variable income that you get, but have no direct way of withholding taxes for. It includes income from interest (savings and CD’s), dividends, capital gains, self-employment income, IRA and certain Roth distributions. You can however still withhold taxes for these items via your paycheck (or make a quarterly estimated payment). A good way to ensure you have enough set aside is to submit an updated W4 towards the end of the year when you have a much better idea of what your taxable “investment” income will be for the year.
Itemized deductions – If there are going to be significant changes in the amount of itemized deductions or tax credits you can claim, then make sure you adjust your withholding. Itemized deductions include:
- Medical expenses
- Deductible home mortgage interest and state/local property taxes
- Charitable donations
- Job expenses
- Dependent care expenses
- Net gambling income
Tax credits for which you can adjust your withholding include:
- Child tax credit
- Education expenses
- Earned income credit (EITC)
- Foreign tax credit
- Certain economic recovery act stimulus credits
Changes in tax deductible income – Certain payments can be deducted from your income for which you should adjust your paycheck withholding. This includes IRA deductions, health savings account deductions, student loans interest, jury duty pay and alimony expenses.
For more on the above see IRS publication 505, Tax Withholding and Estimated Tax