If you're like many taxpayers, the largest chunk of your annual tax is automatically withheld from your regular paycheck. Most of us breeze through the year, erroneously assuming that those withholding taxes will completely cover our entire yearly liability. That can lead to some nasty surprises when April 15 rolls around.
Summer is the best time to make sure that your W-4 withholding for the year is up to speed with your income. Sure, much of the year has passed, but there's still plenty of time left to change your withholding status (and, yes, shrink your paycheck a bit) as painlessly as possible.
Why should you care if you have a big balance due at the end of the year? One word: penalties. If your balance due is greater than $1,000, the IRS may slap a significant penalty on top of it. Besides, it can be tough to scrounge up a wheelbarrow full of cash for Uncle Sam, especially with just a few days or weeks until the April 15 deadline.
: The tremendous number of tax law changes in 2004 and 2005 could affect your tax liability. Make sure that you know and understand how those laws apply to you.
of rental or investment property
: If you've sold or plan to sell this type of property before year's end, your W-2 withholding will probably fall woefully short. Even a small gain on the sale of such property, albeit at long-term capital gains rates, could throw your taxes completely out of whack.
: Again, the sale of stocks for a profit, even at preferred long-term gains rates, could increase your tax liability and swamp your withholding amount.
: Did you get married this year? Or divorced? Either one can affect your withholding. While many of the recent tax law changes have done much to reduce the marriage penalty, tying the knot still leads to higher taxes. It's quite likely that a married couple earning similar incomes will pay more tax -- sometimes substantially more -- than if they filed as single individuals. Similarly, if you've gone through a divorce in 2004, don't make your fiscal matters worse thinking that your withholding will be just fine. It never hurts to check.
Job change: Usually, a job change comes with a salary increase -- perhaps even a signing bonus. You'll want to make sure that you've withheld enough, especially on "lump sum" payments such as a signing bonus or a severance package from your prior employer.
: Did one of your kids move out? Did one of them outgrow the child tax or child care credits? Even if your income remains the same, it's quite possible that your tax liability will increase from the loss of these benefits.
- Commissions or bonuses: If your income fluctuates from paycheck to paycheck, or you receive one or more bonuses throughout the year, be especially wary of your withholding. The tax withholding tables often don't even come close to anticipating the appropriate withholding when your income swings wildly in either direction.
Again, these are just a few of the changes you'll want to keep in mind. There's another good reason to review your withholding, though. What if Uncle Sam's taking out too much of your hard-earned money? A large refund is always nice, but it's fiscally inefficient -- why give the government an interest-free loan? Couldn't you make better use of that money over the course of the year?
To review your withholding, head for the IRS website and check out Form W-4 and the associated instructions. There's even a spiffy little calculator that you can use to help you with your computations. It's a quick and easy way to make sure you're not caught short next spring.
When he's not dealing with tax issues, Roy Lewis is a motivational speaker who lives in a trailer down by the river. He understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns, as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.