The Seven Times To Adjust Your Withholding

 Welcome to another edition of Mastering Business Basics. You know, in the last two decades that I've been doing taxes for people, one problem that always comes up once or twice or three times a year is people sit down to do their taxes, and they have this huge tax bill, and they can't figure out why. 

So I look at their W-2s and say, "Well, do you realize you didn't have any withholding?" Or, "You only had a hundred dollars withheld for the entire year?" And they totally freak out. 

So this is a subject that a lot of people don't understand, especially since 2020 when they redid the tax laws, and that's something I want to address today. More importantly, I want to go through the seven times when things happen in your lives that you need to redo your W-2 withholding to compensate for them.

Links in this episode: 

     https://www.irs.gov/w4
     https://www.irs.gov/individuals/tax-withholding-estimator

Transcript

Episode 14 - The Seven Times to Adjust Your Withholding

Roger: Welcome to another edition of Mastering Business Basics. You know, in the two decades that I've been doing taxes for people, one problem that always comes up once or twice or three times a year is people sit down to do their taxes, and they have this huge tax bill, and they can't figure out why. So I look at their W-2s and say, "Well, do you realize that you didn't have any withholding?"

Or, "You only had a hundred dollars withholding for the entire year?" And they totally freak out. So this is a subject that a lot of people don't understand, especially since 2020 when they redid the tax laws, and that's something I want to address today.

More importantly, I want to go through the seven times when things happen in your lives that you need to redo your W-2 withholding to compensate for them. Let's get started

Announcer: You are listening to the Mastering Business Basics podcast, where we discuss how to build a solid foundation under your small business to improve your chances of success. And now, here is your host, Roger Pearson.

Roger: The US federal income tax system had its beginnings back in 1913. Actually, the first, nationwide taxes was in 1861, and it was a temporary tax of three percent just to pay for the civil war. But the income tax system as we know it today was actually started in 1913 when the Sixteenth Amendment was passed, and it's changed many times since then.

I remember the first year I did taxes, I had a gentleman bring in, he was in probably his eighties at that time. He brought in his tax form from back in the thirties. And it was interesting. It was a three by five card, and you wrote your name and tax ID on it, and you put down how much you made that year, and you multiplied that by three percent, and you sent it in to the government with a check.

And that was how you paid your taxes. The problem ensued that people stopped doing that. They didn't send the checks in. And the government said, "Well, we have a little problem here. We'll just impose on the employers in the country, and we'll solve it that way. We'll just have them withhold a part of your pay and send it to the government for you so that you don't forget to do it."

And that's how withholding came about.

Prior to 2020, most people learned that they could control the amount that was withheld by just changing the amount of exemptions on their W-4 form. And if you wanted to have more money withheld, you reduced the amount of exemptions that you claimed.  If you wanted less money withheld, you increased the amount of exemptions that you had, and that would do the math for you.

There's a lot of people that wanted larger refunds simply because... And this always amazed me. I said, "What do you want an eight or nine thousand dollar refund for? The government's just holding your money there, and they're not paying you interest on it ." And they would tell me, "Well, I don't have the self-discipline to put money in a savings account and let it sit there. I'd end up spending it. This is the only way I can save up money for that big screen TV or the trip to Disneyland or whatever it may be that year." And that was always interesting , the things that they told me that they did this for.

In Trump's first term, the laws changed a lot, and they took away exemptions, so you could no longer make adjustments this way. And at the same time, a couple other major things became more common.  Payroll systems became automated. So you don't fill out paper forms anymore. You go into a computer and answer questions, and you hope you answered them right to get your withholding right.  Forget asking HR for help in filling them out.  Most won’t explain how things work due to liability reasons - if they even know themselves.

And the other thing is people don't get pay stubs anymore. If you want to look at a pay stub, you have to go into some accounting system, and you have to look for your withholding. And when that happened, that really messed people up because I'd have people come in at tax time, and there was no withholding on there. And they had no clue because they had never looked at their pay stub to see if how much money was being taken out of their pay, what percentage was coming out to cover their taxes. And so that created a problem also.

So when you combine that with the changes to the tax law in 2020, it was bound to mess up a lot of people.

But I want to start out today by talking about the seven times that you need to go in and change your W-4 and adjust your withholding. A lot of people actually, I have found out, have the idea that when you fill out your W-4, when starting a new employer, that's the way it is from there on. I've had other people think you can only change your W-4 once a year and that's not the truth. You can change your W-4 as many times as you need to during the year, and you should.

And there's seven specific times that you need to be changing your W-4 as your situation in life changes, because the IRS is now of the opinion that they don't want to be people's piggy banks anymore. They devised a system that if you follow their worksheets and everything, your tax liability is going to be within a couple hundred dollars of what you actually owe at the end of the year - one way or the other.  They want to get it down to that precise. 

Obviously, most people aren't going to do that. But the other hand, I don't know about you but I don't like the government holding my money. I can use it much better than they can, because all they do is waste it, in my opinion anyway. So here they are the seven life events:

The first one is, of course, is obvious. When you start a new W-2 job, you have to fill out the W-4 telling the employer how much you want them to withhold for you.

The second one, if you get a second job. Getting a second job is really a very common reason for errors, especially in this day of so many people looking for extra income.   Now you have to understand why that's important. Because the way the withholding tables are written is that they assume you only have one job. And they withhold the money based on how much you're going to make on that one job. But the withholding table doesn't know that you have this other job over here. And when you add that money for that other job, it's going to put part of your money into a higher tax bracket.

And you're going to end up owing more tax, which could give you a balance due at the end of the year instead of getting a refund back, unless you go tell it. And the way you tell it is by redoing the withholding on your W-4. And we're going to go into how to do that in a little bit here.

The third reason could be is if you're unemployed for part of the year. If you get laid off your job and you're off for several months, and then you get another job - to avoid paying too much tax, you could adjust the withholding on the W-4 form for the new employer for the rest of the year to have less withheld since your overall taxes will be lower. 

But you have to remember, the following year in January, you need to go in and adjust it again for a full year so you have the proper withholding.  So you have to be careful about making those adjustments. But if you really wanna get accurate, want to get close to what you owe through the year, and keep more money in your pocket - these are some things you need to consider.

The fourth, and probably one of the most common, is the taxpayer's spouse gets a job. So now you have two incomes coming into the household. And remember I said that the withholding tables only assume you have one job coming into the house instead of two. So you have to do some calculations to figure out how much of that extra income is gonna bump up the percentage you pay in taxes, and you have to add that amount in part four of the W-4 for one of the spouses. I'll get into that later.

If you get married or you get divorced is number five, and that's gonna make a major change. I've had so many people, they got a divorce, and the last thing they thought about was their withholding. They did not go back in and do a new W-4 saying, "Okay, I'm single now." You need to start withholding more money because obviously the standard deduction for a married couple is more than the standard deduction for a single taxpayer.

Single people pay the highest tax rates. That's just the truth. So you always need to make an adjustment. If you get married, change it to married filing joint, or if you're getting divorced, you have to go back to single, or you're going to have problems when you do your taxes for the year.

The sixth one if you get a new child coming into the household, because there are child tax credits. From age one through 16, you're going to get a $2,200 Child Tax Credit for each child . And from 17 on, you can get the Other Dependent Credit, which is a $500 credit. There's a section to put that information in on the W-4, and the software that figures all this out for you takes the credits that you're going to get into account and therefore reduces the amount that they're going to withhold from your paycheck, because they know you're going to have those credits there to help cover your taxes.

Some people have other relatives that also live in their house. They may have parents that live in your house that you claim, if you provide more than half their income and a few other qualifications. And if that's the case, then you have an Other Dependent Credit that's worth five hundred dollars, the same as any child dependents that you have age seventeen and older.

So you have to take that into account. And of course, if they're no longer with you, you have to go change it again. Every time you have a new child, every time a child gets old enough and moves out on their own and starts supporting themselves, you have to go in and change your W-4 to compensate for that, to tell the system, "Hey, I don't have these credits anymore," or, "I do have these credits now. "

And then there was the One Big Beautiful Bill Act that just passed last year, and those added deductions for qualified tips income, which is going to reduce the amount of tax you owe. Or the deduction for qualified overtime income, which is going to reduce the amount of tax that you owe.

Those would be a little more complicated to figure into the equation. And for most people, I advise they don't do them unless there's a huge amount of overtime or a huge amount of tips in proportion to your overall income. And you probably want to talk to a tax professional if you want to get that finite of narrowing down your withholding.

So those are the main reasons that you need to adjust your withholding, and you should generally try to do it within ten days of when the change occurs so that it takes effect in a reasonable amount of time for you to get the withholding adjusted.

So what about this Form W-4? I'll put a link to that in the show notes if you want to follow along, you can.

There are five parts to the new W-4 form. The first part is very obvious. You just put in your name and your Social Security number and what you believe your filing status should be, and then that's it. Now, if you're single and you only have one job, the only other thing you have to do is go down to part five,  sign your name and enter the date. That's it. But for most people, life is a little more complicated than that.

Part Two applies in two situations. If you're single and you have more than one job, or if you're married and your spouse works, then there's some extra figuring that you have to do. Remember that the tax table assumes there's only one job in the household and it withholds based on that.

So we have to do a little math to figure out how much extra needs to be withheld from one of the paychecks to compensate for the higher tax rates a double income is going to create.

Now the IRS has a worksheet in the W-4 instructions that you could follow along to try to figure all of this out. What basically happens is that the worksheet takes the income from both incomes. It figures them two ways. If you were filing each income separately, how much tax would have to be withheld on each one to cover the tax liability?  

And then it also figures adding them together, how much tax would have to be withheld to compensate for the total income, which normally puts part of your total income in a higher tax bracket. And then you take the difference between those two calculations and you add it down in Part 4-C of the W-4 on the person that makes the highest amount of money.  And that is how you compensate for having multiple incomes so that you don't have a shortfall when you go to do your taxes.  Sound complicated? Don’t worry, there’s software that can do the math for you. 

Part Three goes into dependent credits. Now, as you probably know, if you have children, and they're age one through 16, you're going to get a $2,200 tax credit for each one. If they're 17 and older, there's something called the other dependent credit, and you get a $500 tax credit if you meet the qualifications.

So when you have a child, you have to go in and you say, So when you have a child, you go in and you say, "Okay, I have one child under age 17, so I'm going to get a $2,200 credit." And when that child turns 17, then you need to go in and you need to adjust it also.

Change it from a credit at $2,200. "Okay, I have one child now that's 17 or older, so I'm going to get a $500 credit instead” Because when the child ages out of the child tax credit, then you're gonna lose $1,700 in credits there. And if you're counting on that to reduce your taxes, you're gonna be sorely disappointed when you do your taxes that year.  That's one of the major things that you need to keep track of and you may need to make changes for.

You can also add some other credits there if you want to get a little more finite. For instance, if you know you're going to get a twenty-five hundred dollar education credit for college, because you've got one of your kids going to college - you can add that to the line for other dependent credits.  So it's going take that into account when it figures out what withholding you need to have. If you have an extra $2500 credit out here, you don't have to withhold as much because it's already been compensated. 

Part four has three types of adjustments. We already talked about part 4C being where you put in the extra withholding you have to have because you've got more than one job in the household.  Part 4A is where you list any other types of income coming into the household that does not have any withholding on it such as self-employment or investment income.  (Remember to only list this on one of the W4s in the household.)

Step 4B is for people that don't use the standard deduction, but they itemize. Say the standard deduction is $32,000 for you, but if you do Schedule A itemizing, you can deduct $50,000. So you put that $50,000 in step 4B and then it won't use the standard deduction as calculations, but it'll use the Schedule A itemized deductions instead.

And of course, step five is for you to just sign the form and you date it. 

We used to do everything on paper. Now you go into and you do it online. But the problem with a lot of the online programs is they really don't explain things to you. You just fill in the blanks, you know, mark this, mark this, so forth and so on, and you have no idea.

And I've had so many people tell me they go to HR, and they ask HR for help in understanding their forms, and HR will not help them because there's a liability issue with that. So you need to educate yourself on all of these things so that you know how to fill out the W-4 to correct your withholding, how often you need to do it, when you need to do it, and keep track of it.

And look at your pay stubs to make sure that the right amount is coming out.  I can't emphasize that more. You have to look at your pay stubs. I constantly look at mine so I know what's going on because I don’t trust computer software - especially when a business switches payroll companies and everything is moved over to the new company.  I’ve seen a lot of mistakes with that happening.

A couple other things I want to mention. There are instances where you can make yourself exempt from withholding. You have to be careful, though. There's two instances where you can do this. Now, if you know that you're not going to owe any taxes because you've got enough child tax credits, education credits and everything else,  you can actually claim at the bottom of the W-4 that you're exempt from withholding, and they won't take anything out at all.

You're not going to have a large refund because of that, but on the other hand, you've got money in your pocket to use during the year to live on, instead of giving it to the government and letting them hold onto it so that you can get it back when you do your taxes. The other is if you are going to make less than the standard deduction, you don't have a filing requirement because you're not going to owe any taxes.

So, if you know that your standard deduction is $15,000, but you're only going to make $12,000 a year, then you can put exempt on your W-4, and you won't have any taxes withheld. And you wouldn't even have a requirement to even file a tax return because you didn't make enough money to even need to.

So those things you can keep in mind also. That's a very rare thing because you don't know how life can change. But if that happens to you and suddenly you get a higher paying job that's going to cause you to pay taxes, then you better put in 4A how much other income you made during the year how much you made in that other job that you weren't having taxes taken out of so enough can be taken out of your new job to compensate for that or you're going to owe taxes at the end of the year.

There's one more thing that I want to tell you about, and that is the IRS has something called a Withholding Tax Estimator on their website. I mean, it used to be that you had to download the W-4 manual, and you had to go through it, and you had to look at worksheets, and you had to fill out the worksheets and do all the calculations.

But now they put that actually on the website. I'll put a link to it down in the show notes also.  They say that produces the most accurate means to determine what your withholding should be.  Then you can use the results of that to determine if you should complete a new W-4 or make estimated tax payments to the IRS. The estimator is designed to provide precise results, meaning that it helps taxpayers determine the amount of withholding they'll need to break even with their tax liabilities.

If you wish to receive a higher refund, then of course you could compensate that by having additional tax withheld. And again, that's in step 4C of the W-4. There are some caveats to using the estimator though. You need to have a regular W-2 paycheck or a pension that has withholding on it. And those two things are the base requirement.

You can then add other things to that, like alimony, taxable scholarships, unemployment compensation and self-employment, but it won't work unless you have a base W-2  income or a pension with withholding on there.  You're going to need your most recent pay stub from all the jobs held in the year and the spouse's, if that's the case. Also, your other income, like from side jobs, self-employment, investments, any deductions that may impact your tax results and a copy of your most recent tax return.

They actually recommend that you review your withholding annually, which I think is a very good thing because your life gets in the way, things happen, your situation changes, and the last thing on your mind is adjusting your taxes. But it should not be, because, as they say,  there's two things you can't get away from, death and taxes.

There's a couple of situations where you can't use the IRS withholding tax estimator. If you're on a pension or job that does not have withholding.  If you're a non-resident alien, you can't use it. And if your tax situation is really complex, like you owe AMT tax, you have long-term capital gains, or you have a bunch of qualified dividends, the estimator won't get into that either.  You actually have to sit down and figure out things by hand if you're going to do that. 

As a final note, when people end up owing a lot of money because they haven't looked at their pay stubs or they haven't filled out their withholding properly, I’ve had people want to be able to go back and have the employer fix it so they don't have to write the check to the IRS. And it is not the responsibility of their employer to fix it. Once you've got your W-2 and it's messed up, it's messed up. It's your responsibility to come up with the money to pay your taxes, not your employer's. So remember that. It can't be fixed. That's why it's important you know all this information, you know how it works, and you know how to manipulate it and fix it.

So I hope you've learned something today. I hope you've learned some things you need to take into consideration. Every taxpayer in the country needs to know this type of information and how to address it because your life will change, complications come along, and you can't get away from paying taxes, so you might as well learn how to do it the most effectively that you can to not give any more money to the government than you need to.

And that's one of the reasons I'm here. So until next time.

Announcer: You have been listening to the Mastering Business Basics podcast with your host, Roger Pearson. For more information about all of the business education options that are available, we invite you to visit seagulltechnologies.com and continue your journey.