As CPAs, we are often asked about federal tax withholding — “How do I know if I am withholding the correct amount?” or “If I change my withholding amount, will I owe less at tax time?” By understanding how federal tax withholding works, you can avoid a surprise during tax season.
The Federal income tax is a pay-as-you-go tax, meaning you are expected to pay tax on your income as you earn it throughout the year. At year end, your actual tax bill is calculated, based on not only your income, but also any life events, dependents, your filing status, charitable contributions, deductions, and other factors. If your payments throughout the year were greater than the actual amount owed, you’ll receive a tax refund. If you underpaid, you’ll owe the remainder to the IRS.
Throughout the year, payments can be made in two ways: by withholding from your paycheck, pension, or social security payments; or by making quarterly estimated tax payments (people who are self-employed generally pay their tax this way).
If your tax bill this year was larger than you expected, you may need to adjust your withholding amount or make estimated tax payments. It’s especially important to check your withholding if any of the following life changes occur:
Now is a great time to do a “withholding check” to ensure that your federal tax withholding amount is correct for the year ahead. Your CPA can help you determine if you need to make any changes. You can also use the tax withholding estimator tool on the IRS website to estimate your current income tax, and compare that to your current federal tax withholding to help you decide if you need to change your withholding amount. State withholding is separate and varies depending on the state you live in.
If you have questions about tax withholding, leave a comment below or feel free to contact me directly. I’m happy to help!