It may be smack dab during the 2023 tax season, but it’s never too soon to assess whether you’re earmarking enough funds for next year’s tax filing. Tax withholdings, after all, are merely estimates, and they could either leave you with too much or too little cash come tax time, depending on your income and tax situation, which may have shifted since your last filing.
Underestimating your contributions could lead to an unexpectedly hefty tax bill next year, possibly even triggering an underpayment penalty. This is due to the pay-as-you-go nature of the U.S. tax system, which requires freelancers and self-employed individuals to make regular quarterly tax payments throughout the year.
On the flip side, overestimating your withholdings might mean depriving yourself of much-needed monthly funds without good reason, essentially loaning the Internal Revenue Service money interest-free.
Here’s how you can review your tax withholdings and make adjustments if necessary.
Why your tax withholding might need tweaking:
Whether you calculate your tax withholding yourself or rely on an employer via a W-4 form, any alteration to your tax liability size or the amount you owe could necessitate changes to your withholding. Factors like changes in marital status, retirement contributions, tax credits, healthcare debts, or adding dependents can all influence your tax situation significantly.
“For those who are in the 22% marginal federal tax bracket, this is not a problem at all. However, those in a higher tax bracket could owe huge taxes,” says Carla Adams, a certified financial planner in Michigan.
How to verify if your tax withholding is on point:
To determine whether you’re underpaying or overpaying your 2024 taxes, begin by identifying your current withholding rate. You can find “federal income tax withholding” or “fed tax” amounts on a recent pay stub for both the last pay period and the year to date. Alternatively, reach out to your employer’s human resources department to confirm these figures.
Once you have these amounts, input them into the IRS’ tax withholding estimator. This tool provides an estimate of the taxes you’ll owe by year-end and alerts you if you’re currently overpaying or underpaying taxes for the 2024 tax year.
Based on these calculations, the IRS tool generates an updated Form W-4 with the necessary tax adjustment already incorporated, whether it’s an increase or a decrease. Simply download and submit this form to your employer, who will implement the adjustment accordingly. Remember, employers typically handle tax withholding only for the income they pay you, not for freelance or self-employed income or windfalls like lottery winnings.
If you’re self-employed, filing your tax return can be more complex. Tax software can provide estimates for your expected quarterly tax payments, or you can use Form 1040-ES, which includes a worksheet to help you calculate your tax liability. You can pay your estimated quarterly taxes on the IRS payments page.
Ultimately, it’s up to you to ensure the appropriate withholding throughout the year. Chris Mankoff, a CFP in Texas, suggests checking your withholding at least once every three months if you file a W-4, either via the IRS withholding tool or a tax professional. If you’re self-employed, he recommends using tax software or consulting a tax professional.
