When Should You Adjust Your W-4 Withholdings?

Major life changes impact the amount of taxes withheld from your paycheck

In the U.S. tax system, most individuals take the pay-as-you earn (PAYE) approach, in which estimated income tax is paid throughout the year and then accounted for on tax day of the following year. Taxpayer's employers are legally required by the federal government to withhold part of their employees' income for taxes by deducting a portion of their regular paychecks.

To calculate the precise amount they withhold, employers rely on the information all new employees fill out on their Form W-4 forms. If too much tax is withheld, employees receive refunds. However, a lot can change over the course of a year. In certain circumstances, it makes sense to revise the amount of tax that gets withheld.

Key Takeaways

  • The United States' pay-as-you-earn tax systems encourages taxpayers to withhold federal income tax from their paychecks.
  • Your marital status (and changes to it) has a material impact on your tax return.
  • As your family expands and more dependents are added, you may be eligible for additional deductions and tax credits, meaning less taxes might have to be withheld.
  • Major life purchases such as the purchase of your first home result in tax benefits that reduce the amount of taxes owed.
  • You can change how much to withhold by submitting a revised Form W-4 with your employer.
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When You Should Change Your Withholding Tax

Most individuals have until April 18, 2022 to file their 2021 federal income tax return. Taxpayers in Maine or Massachusetts have until April 19th due to Patriots' Day in those states. All taxpayers that request a filing extension will have until Oct. 17, 2022 to file.

Events That Trigger Changes

The amount of taxes withheld is governed by the following considerations:

  • Whether you file for a "married" or "single" rate on your W-4
  • The amount of income you earn (across a single or multiple jobs)
  • Whether you wish to withhold extra funds
  • The number of allowances you qualify for

Changes in your household situation, such as the birth of a child or a spouse losing a job, can immediately impact your tax situation. In these situations, it is well worth changing the amount of withholding to avoid owing a bigger tax bill than necessary.

Marriage

If you are married and filing a joint tax return, your taxes may be impacted in the two ways. First, If your spouse earns an income, your overall household withholding may increase. Second, if your spouse doesn't work, your overall withholding will likely decline. There are also situations in which separate filing makes sense.

Divorce

Divorce can alter your household income, but there is also the matter of alimony. Alimony began receiving a different tax treatment starting in 2019 thanks to the Tax Cuts and Jobs Act signed into law in 2017. Under the new tax paradigm, alimony payments will no longer be tax-deductible for the payer, while recipients do not have to declare alimony as income.

Birth or Adoption

The birth or adoption of a child immediately adds a dependent to your household and lessens the overall tax burden, in an effort to compensate for the costs of raising children. To capitalize quickest on the credits and increased deduction, consider reducing your withholding.

When your children grow up and if they move out, you should consider readjusting your withholding as you may no longer be eligible to claim them as a dependent.

New Home (or Other Major Purchases)

When purchasing a home, you can update your withholding in anticipation for tax benefits. There are number of credits for first-time homebuyers, and the list of tax benefits approved by the IRS regularly changes.

This holds true with any large deductions or credits you may become eligible for within a given year, including education credits, dependent care expenses, medical expenses, and charitable donations.

Big Increases in Non-Wage Income

You must adjust your withholding to account for any non-wage income from side businesses, stock dividends, or interest income. For example, if you successfully invested and sold equities or cryptocurrency for a profit, those proceeds are subject to short-term or long-term capital gains depending on your holding period.

Working Two Jobs

Two-income households and individuals who work multiple jobs are vulnerable to withholding disparities. This is especially true if each withholding certificate is completed to withhold an amount specific to each job. For example, working two different jobs that each pay $25,000 pushes a taxpayer into the 22% tax bracket in 2021. However, independently, each withholding certificate may assume the taxpayer caps out in the 12% tax bracket.

Similarly, losing a second job allows you to reduce the withholding on your remaining job or claim allowances you were previously holding off on.

Getting Your Withholding Right

The IRS provides features a useful withholding calculator on its website. In addition. Form W-4 has instructions along the form in addition to a separate set of instructions. An overview of the steps to revise your tax withholding is below.

  1. Use the IRS online Tax Withholding Estimator to estimate what your federal income taxes will be.

  2. If you determine the change in your taxes are large enough, contact your employer about wanting to revise your federal income tax withholding. Your employer may give you a blank W-4 form to complete or may direct you to an electronic platform to submit the information.

  3. If you have multiple jobs or if both you and your spouse work, complete Step 2 of Form W-4. The information from this step is used in the steps below.

  4. If you have dependents, complete Step 3 of Form W-4. This step determines what portion of your income is reduced due to the dependents you are claiming.

  5. If you work multiple jobs, you can decide to have all taxes withheld on one W-4. To select this option, enter in the amount that would have been withheld in your other role on Step 4(a) of Form W-4. Remember to opt out of withholding on your job if you choose this option.

  6. If you anticipate receiving other tax benefits during the year, you can choose to further reduce your tax base. On Step 4(b) of Form W-4, enter the amount you expect to not need to pay. For example, taxpayers that are buying their first home are eligible for additional tax deductions, though this must be deliberately included on a W-4 on this line to appropriately reflect that benefit.

  7. If you expect that you'll need to pay more taxes, you can opt to withhold an extra amount by entering the additional amount on Step 4(c).

  8. Upon submitting a revised form to your company, ensure the appropriate changes have been made by comparing your previous and current pay statements. Changes to your withholding amount may be delayed one or two pay cycles.

Coordinating with Spouse

While you cannot claim the same allowances as your spouse, you can split them up

Is It Better to Withhold More or Less Taxes?

If you want to avoid paying taxes as part of your tax return, it is better to withhold more taxes. However, there is a lost opportunity when withholding more than you need. By overpaying taxes in advance of when they are due, you lose the opportunity to invest those funds and potentially grow your capital.

Will Changing Withholding Affect My Paycheck?

Yes, changing your tax withholding will change your take-home pay, though your gross pay will not change. Increasing your tax withholding with reduce your net paycheck amount, while decreasing your withholding increases the amount you take home.

How Do I Update My Withholding Amount?

If your employer withholds taxes on your behalf, you can submit a revised Employee's Withholding Certificate (Form W-4).

The Bottom Line

People may go years without the need to significantly alter their withholding status. But when life changes do occur, it's worth taking the time to re-file the W-4. If you pay out too much to the government throughout the year, you will be refunded. But if you pay out too little, you may be surprised by a large bill.

Article Sources
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  1. Internal Revenue Service. "Publication 15: (Circular E), Employer's Tax Guide," Page 9.

  2. Internal Revenue Service. "2022 Tax Filing Season Begins Jan. 24; IRS Outlines Refund Timing and What to Expect in Advance of April 18 Tax Deadline."

  3. Internal Revenue Service. "Publication 505: Tax Withholding and Estimated Tax."

  4. Internal Revenue Service. "Publication 505: Tax Withholding and Estimated Tax," Page 6.

  5. Internal Revenue Service. "Two-Income Families, Taxpayers Working Multiple Jobs Should Check Withholding Amount."

  6. Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2021."

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