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Money Leaks: Inaccurate Tax Withholding

Posted By Jim On 10/13/2011 @ 7:15 am In Career | 1 Comment

Whenever you get paid, a portion of it is withheld by your employer for tax purposes. It’s sent to the Treasury Department each month and it goes towards your annual tax bill. We’re a pay as you go system, so you’re required to pay taxes on your income as you earn it. This is accomplished by this withholding and quarterly estimated payments, if they apply to you.

The amount that is withheld is based on your W-4 [3], a short form in which you briefly explain your family situation. Based on your tax filing status, number of dependents, and a few other criteria, your employer withholds a set amount. If you get a large refund check each year, you’re withholding too much. If you pay a large amount, including a penalty, then you’re withholding too little. Both are bad.

This is the latest edition of our new series called Money Leaks. [4]

Overwithholding

Overwithholding is where your employer is withholding too much and so you get a large refund check in April (or May). Overwithholding is bad because that’s your money that can be used to pay for your needs, pay down your debts, or be saved into an interest bearing account. Isn’t it better to have your own money than pay taxes you don’t really owe?

Underwithholding

This is a rarer case but sometimes you could be underpaying your tax liabilities and that’s bad because the IRS will assess penalties. There are safe harbor payment amounts [5] that can protect you against penalties, but you still owe the extra taxes (something you may not have accounted for). Underwithholding is clearly the worse of the two.

How to Fix

Many places will tell you to work with calculators to find out what you need to put on your form. I suggest you use those calculators but also talk to your HR department. They do this every single day and explain your situation, they should be able to help you out. If you are stuck with an uninformed HR department, then rely on the calculators more and submit a new W-4.


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[2] Email: mailto:?subject=http://www.bargaineering.com/articles/money-leaks-inaccurate-withholding.html

[3] W-4: http://www.irs.gov/pub/irs-pdf/fw4.pdf

[4] Money Leaks.: http://www.bargaineering.com/articles/tag/money-leaks

[5] safe harbor payment amounts: http://www.bargaineering.com/articles/irs-safe-harbor-income-tax-underpayment-rule.html

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