Time to Check Your Tax Withholding?

GettyImages 942154464It is a good idea to check your federal income tax withholding at least once a year. Adjustments may need to be made to make sure you are having an appropriate amount of tax withheld.

Ideally, your employer should be withholding enough tax from your pay so that by the end of the year, your total tax liability and total payments made will line up closely. Otherwise, if you end up owing a lot to the IRS at tax time, you might have trouble coming up with enough cash to pay the amount due, which might include interest and penalties on top of tax. Or, if you get a big refund, it will mean you basically gave the IRS an interest-free loan during the preceding year.

Situations That Might Mean It is Time to Change Your Withholding

Your employer may already be withholding an appropriate amount of tax from your pay. However, if your return for last year reflected a substantial underpayment or overpayment, you should revisit your withholding if you have not already done so this year.

Even if your withholding was pretty much on target last year, giving it a fresh look is especially important if any of the following circumstances apply to you:

  • You have significant non-wage income, such as interest, dividends or alimony, or the amount of your non-wage income has changed since you last gave your employer a W-4 (the federal withholding form).
  • Your filing status is "married, filing jointly" and your spouse started or stopped working since you last submitted a W-4.
  • You or your spouse are working more than one job.
  • You've had a major life change (such as a marriage, divorce, job change or promotion; the birth or adoption of a child; or the purchase of a new home) that might affect your ability to take certain tax deductions or credits.

Consider Any Impact of the CARES Act on Your Taxes

You may also wish to revisit your withholding if you expect your taxes to be affected by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law in March of this year in response to the economic decline triggered by COVID-19. Among the CARES Act provisions is a new, above-the-line deduction of up to $300 for cash donations made in 2020. (An "above-the-line" deduction is one that is available even to taxpayers who take the standard deduction instead of itemizing.) If you plan to use this deduction, it may be advisable to adjust your withholding accordingly.

Also, the Act suspended the mandatory 20% tax withholding that normally applies to early distributions from a 401(k), 403(b) or another workplace retirement plan. You still owe tax on such a distribution, but the CARES Act lets you spread the tax liability on the distribution over three years.

The CARES Act provided a "recovery rebate" of $1,200 for each taxpayer (or $2,400 for a married couple filing jointly), but the rebate is not taxable.

How to Check Your Withholding

For help with figuring out how much tax to have withheld from your pay, use the IRS's Tax Withholding Estimator. Compare the result you get from the estimator with the amount of tax currently being taken out of your pay.

How to Change Your Withholding

After using the estimator, you may find that your withholding is due for an update. To change your withholding, you will need to complete a new W-4. You can either get this form from your employer or download it here.

The W-4 was recently simplified and shortened to make it easier to understand and use. Complicated worksheets have been replaced with a series of questions about your income and dependents. The hope is that your answers to these questions will lead to more accurate withholding and fewer surprises at tax time.

The W-4 no longer uses allowances in determining how much tax will be withheld from your pay. In the past, the value of each allowance you claimed was linked to the amount of the personal exemption. But under the Tax Cuts and Jobs Act, passed in 2017, taxpayers can no longer claim personal exemptions.

Questions about withholding? Contact your EY planner.

The Pension Boards offers EY Financial Planning Services at no cost to actively-contributing, inactive, and annuitized Annuity Plan members. Call the EY Navigate Financial Planner Line at 1.877.927.1047 or visit pbucc.eynavigate.com to learn more.

The article is used with the permission of Ernst & Young LLP.