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Are You Taking Out Too Much or Too Little in Taxes from Your Paycheck?

Income earned from wages is taxable if it exceeds a certain amount. If the income earned is from wages, the employer withholds taxes from the paycheck of the employee and transfers them to the IRS. The amount an employer withholds depends upon the wages and the information provided by the employee on Form W-4.

How Inaccurate Withholding Affects You

paycheckIf you have a single source of income, i.e. from your job, then your tax liability might not have changed from previous years. However, if you receive income from other sources such as from interest, rent, dividends, etc. it is wise to check if you have too much or too little taxes withheld.

Getting too little taxes withheld causes paying less than what you owe. The IRS charges penalties and interest every month on unpaid taxes after the the filing deadline. This substantially increases the back taxes over time.

On the other hand, getting too much withheld is tantamount to giving the IRS an interest-free loan, which is returned to you as a tax refund. This excess amount can be used for investment or spending. If you received a bigger refund this year or last year, it is an indication that you are withholding too much.

Life Changes That Impact Your Tax Liability

It is time to review your W-4 withholding when certain changes occur in your life. These include:

1. Change of job
Fluctuations in income can alter your tax liability. If you did freelance work for a friend for which you earned extra income, you will need to pay taxes on this money. A change of job may lead to an increase/decrease in income, in which case a new W-4 needs to be provided.

Tips, royalties, fees, commissions, fringe benefits, and any income received for personal services is taxable income. Making adjustments to your W-4 will ensure that you pay the correct amount in taxes. For more information, review IRS Publication 525 (2015), Taxable and Nontaxable Income.

2. Marriage or Divorce
A life event that changes your filing status and/or increases/decreases your usual expenses/income will impact how much you pay in taxes. Most married taxpayers file as married filing jointly, as this allows them to save more in taxes. On the other hand, getting a divorce may change the filing status to head of household or single filer.

3. Birth of a Child
The birth of a child makes you eligible to qualify for tax credits, such as the Child Tax Credit and Child Care Tax Credit, and also certain deductions. If you or your spouse looks for a job and you hire help to care for your child, you can deduct the childcare expenses. These tax breaks can reduce your total tax liability, leaving you with fewer taxes to withhold.

Calculating Your Withholding
To check how much you should withhold, you may simply use the IRS Withholding Calculator. You need your most recent pay stubs and your most recent income tax return to use this service. You may also use this tool to determine your withholding when completing a new Form W-4.