Withholding: Good Practices for Optimum Results

Withholding: Good Practices for Optimum Results

How do you measure the success of your tax filing?

It seems to be a common preconception that success of the tax return and its preparer should be measured by the amount of money you get back as a refund. But think of it: it is called a “refund” for a reason and the reason is that you paid it in the first place.

To have the tax withheld from your regular paycheck you fill out form W-4 with your employer.  They put it into the payroll system that figures the amount of income taxes to be held back from each paycheck producing a net amount you get into your hands.  You get used to this net amount, you plan your personal cashflow based on it, and you don’t think of it until April when you get a refund (yay for me!) or have to pay more (does my tax preparer know what they are doing?)

Here are a few tips on how to stay educated and manage your withholding:

  1. Keep in mind, you only have to pay 90% of your tax liability for the year by the end of it – if you owe less than 10% of total tax for the year on April 15, you are a winner – IRS just gave you an interest free loan for a few months!
  2. If you paid less than 90% of tax due for the whole year, the IRS will charge some interest. The rate for the first quarter of 2019 was 5%: simple, annual, and only applicable to the amount “underpaid”
  3. Understand the actual amount of tax you pay during the year, not just the refund or amount due. Look on tax return form 1040 line 15 “Total tax” and compare it to line 6 “Total income” and then to line 18 “Total payments”.  How do they compare to the prior year?  What would you like to do differently next year?
  4. Read your paystub and familiarize yourself with the amounts withheld as Federal and State Income Tax. Multiply these amounts by the number of pay periods in the year and compare that to line 15 “Total tax” of your tax return.  Would you like to change anything next year?
  5. Review your form W-4 each time you have significant life changes: marriage, new child, child starting college, child graduating college, spouse starting/changing a job, etc. Keep in mind though, the actual number of “withholding allowances” you put on the W-4 has relatively small effect on your withholding
  6. Schedule a tax planning session with your tax advisor before the end of the year: let them know about any unusual/irregular transactions or events to see what incremental effect they may have on your overall tax for the year. The tax preparer may recommend a change in W-4 form, estimated payment, or just setting aside some funds for the April 15 filing time.

Our tax system allows for great flexibility and striking the perfect balance between the tax liability and payments could be a challenge.  Stay educated and ask your tax advisor for help to achieve the best results.