Tax Day has come and gone. By now, most people should have either filed their taxes or asked for a tax extension. In fact, many readers may have already received tax refunds — or, less happily, paid their tax bills. This is a good time to look at how much you're withholding from each paycheck for your federal income tax.
Why? Your withholding can affect the size of your tax refund. If you owed money, you may want to withhold more from each paycheck to reduce your bill next year.
Conversely, if your refund was big, that may mean you withheld more money than you actually owed in taxes. You basically paid your tax bill early and let the government keep the change for months. If you think you could have used your money in a better way, you may want to reduce your withholding.
"You just have to keep on top of it so you're not putting yourself in a position to have to write big checks or get hit with penalties," said Allan Katz, a certified financial planner and president of Comprehensive Wealth Management in New York.
How does the new tax law change things?
It's extra-important to check your withholding this year because Congress recently passed tax legislation that increased the amount of pay most people can deduct and pushed more income into lower tax brackets. Most people will owe less as a result, Katz said (unless they live in a high-tax state like New York because of the lower caps on state and local tax deductions, but that's another story). Those people may be able to withhold less money as a result.
How do I check my withholding?
You should check your withholding every year, Katz said. It's especially important if your income changes. Tax season can be a good reminder, because the size of your return can tell you whether you're withholding too much or too little.
The IRS has an online withholding calculator to help you determine how much of your paycheck you should set aside for taxes. You'll need a few recent pay stubs and your last income tax return. Based on your inputs, the calculator suggests a number of allowances to put on your W-4 form, which tells your employer how much of your paycheck to set aside for taxes. The more allowances, the less you withhold.
You may also want to talk to an accountant or tax professional about the best option for your tax situation.
You can contact your human resources department to find out how to change your W-4. Depending on your company, the change should take effect in a paycheck or two.
Then what happens?
Let's say you decide to reduce your withholding.
"Once you have that extra money, the question becomes, what do you do with it?" Katz said.
Depending on your finances, you may set aside more of your paycheck for retirement or savings instead. If you don't have an emergency fund, you can use the extra money to start one, or pay off debt. (We've got some more adult ways to spend your tax refund here).
Remember, if you're setting aside less money for taxes, you can't count on the windfall of a tax return every spring. You'll need to plan for that as well, based on your financial goals.
If you increased your withholding to avoid owing taxes, you also have to adjust your budget. In this case, you'll have to account for having less money in each paycheck.
Changing your withholding usually won't lead to dramatic changes, Katz said. But it's still a good idea to stay on top of it so you don't face unpleasant surprises when tax time comes again.
Curious about how the new tax law affects you? See how your income fits into the updated tax brackets here.