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, your employer will withhold taxes from your paycheck and transfer it to the IRS. The amount your employer withholds depends upon how much you earn and the information you provided on IRS Form W-4.

How Inaccurate Withholding Affects You

If you have a single source of income, i.e. from your job, then your tax liability might not have changed from previous years. If you receive income from other sources, however, it is wise to verify that you are not taking too much or too little in taxes from your paycheck.

Paying too little in taxes throughout the year will result in owing the IRS more at tax time. If you can’t pay your tax bill, the IRS will charge penalties and interest every month on unpaid taxes after the filing deadline. This substantially increases your 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’s always a good idea to do a paycheck checkup at the beginning of the tax year, but other life changes may also require you to make changes to your tax withholding amount.

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 is needed.

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, Taxable and Nontaxable Income.

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 (HOH) or single filer.

Birth of a Child

The birth of a child makes you eligible for certain tax credits, such as the Child and Dependent 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 pay.

Calculating Your Withholding

To check how much you should withhold, use the IRS Tax Withholding Estimator tool. You will 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.