Are you familiar with that feeling of delight when you receive a large tax refund check? It feels like a bonus, right? But hold on. It’s actually your money that the government is returning to you, money that you overpaid in taxes throughout the year. Essentially, it’s an interest-free loan you gave to the government. Doesn’t sound as exciting now, does it?
On the other hand, owing a hefty sum to the IRS come April can cause a different type of shock, leading to financial stress and potential penalties. It’s important to understand that our tax system operates on a “pay-as-you-go” basis, meaning you’re required to pay your tax liability throughout the year. If you underpay, the IRS can slap you with a penalty.
So how do you strike the right balance and avoid both scenarios? The answer lies in getting your tax withholding just right.
In simple terms, tax withholding is the amount your employer takes out of your paycheck for taxes. The goal is to withhold an amount that will cover your total tax liability for the year. When you start a new job, you fill out a form called a W-4, which guides your employer on how much to withhold from each paycheck. Getting your tax withholding as close to your actual tax liability as possible is both an art and a science. It’s about keeping as much of your paycheck as possible without falling short when it’s time to square up with the IRS.
You may need to update your W-4, especially when there are significant changes in your life like a change in marital status, a new job or additional job, or the birth of a child. Remember, a large refund means you’re giving the government an interest-free loan. Owing a little bit of money at tax time isn’t necessarily bad, but owing a lot could mean penalties. If you think you might benefit from reviewing your current tax withholding, Francis can connect you to one of our advisors who can help you take a look at your tax situation and provide guidance on how to submit an updated W-4 to get you back on track with the IRS.