Common lifestyle changes, like getting a job or getting married, can change your tax liability. To avoid being caught off guard by an unexpected tax bill or a huge tax refund, you'll need to adjust your withholdings on your paycheck.
For information on the third coronavirus relief package, please visit our “American Rescue Plan: What Does it Mean for You and a Third Stimulus Check” blog post.
What's a W-4 and why should I pay attention to it?
Every time you earn income, you'll most likely owe income taxes. How much your employer sets aside to pay federal taxes on your behalf is determined by the information you submit on your Form W-4.
When you have too much money withheld from your paychecks, you end up giving Uncle Sam an interest-free loan (and getting a tax refund). On the other hand, having too little withheld from your paychecks could mean an unexpected tax bill or even a penalty for underpayment. The key to paying the right amount of tax is to update your W-4 regularly.
- Do this whenever you have a major personal life change.
- The goal is to reduce the potential for a tax bill and have a tax refund at zero or close to it.
- If you count on a big tax refund every year, you should also pay attention to your withholding because how much you have withheld directly impacts your refund.
Some life events result in more taxes, while others entitle you to credits and deductions that lower your taxes. The list of these events is long, but here are 5 of the most common reasons to revisit your W-4 withholding.
1. You get a second job
Getting a second job is the most common reason for needing to adjust your W-4. Do this whether you moonlight, have a home business or get another full-time job.
Any time your income goes up, your tax liability will likely go up too, requiring a new W-4. If your extra income comes from a side job that doesn’t have any tax withholding, you could submit a new W-4 to adjust the withholdings at your main job to account for the increase in income.
2. Your spouse gets a job or changes jobs
Any change of household income, whether up or down, could put joint filers in a different tax bracket and require both of you to modify your withholdings. To ensure accuracy, use your combined income to figure out the appropriate withholding.
Use TurboTax's W-4 Withholding Calculator to determine the amount of withholding you should state on you and your spouse's W-4s.
3. You’re unemployed part of the year
If you get laid off from your job and stay unemployed the rest of the year, you likely had too much tax withheld while you were working. So, if you get rehired in the same year, you'll need to adjust for the downtime. To avoid paying too much tax, you should adjust your withholding on a new W-4. We'll show you how to do that below.
4. You get married…or divorced
Tying or untying the knot will most likely change your tax rate, especially if both spouses work. Married persons filing jointly qualify for a lower tax rate and other deductions than filing as single. Getting a divorce can take you back to single or head of household status and reverse many tax benefits. If you fail to account for these events on your W-4, your withholdings could be inaccurate.
5. You have a baby…or adopt one
A new baby is more than a bundle of joy. It's can be a major tax event, too.
If you are eligible for the Child Tax Credit, you can include the amount that you will qualify for in your W-4 calculations. Just remember that any amount that you receive as an advance payment during the year will need to be subtracted from the credit that you expect to receive on your tax return since you would have already received this money
If you adopt a child, there's potentially another tax credit. Any of these could allow you to reduce your withholding to account for the added tax benefits.
For tax year 2021, the Child Tax Credit changed for to provide help for families financially struggling due to the pandemic.
Child Tax Credit Changes
The American Rescue Plan raised the maximum Child Tax Credit in 2021 to $3,600 for qualifying children under the age of 6 and to $3,000 per child for qualifying children ages 6 through 17. Before 2021, the credit was worth up to $2,000 per eligible child, and those 17 years old and up were not eligible for the credit.
The Child Tax Credit changes for 2021 have lower income limits than the original Child Tax Credit. Families that do not qualify for the credit using the revised income limits are still eligible for the $2,000 per-child credit using the original Child Tax Credit income and phase-out amounts.
In addition, the entire credit is fully refundable for 2021. This means that eligible families can get it, even if they owe no federal income tax.
New, Temporary Advance Child Tax Credit Payments
The Child Tax Credit has been expanded by the American Rescue Plan Act, that was enacted in March of 2021. Part of this expansion is to advance the 2021 tax credit to families by sending them direct payments during 2021 rather than having them wait until they prepare their 2021 taxes in 2022. Most families do not need to do anything to get their advance payment. Normally, the IRS will calculate the payment amount based on your 2020 tax return. Eligible families will receive advance payments, either by direct deposit or check.
The amount that you receive will be reconciled to the amount that you are eligible for when you prepare your 2021. Most families will receive about one-half of their tax credit through the advance payments. If you receive too little, you will be due an additional amount on your tax return. In the unlikely event that you receive too much, you might have to pay the excess back, depending on your income level.
For updates and more information, please visit our 2021 Child Tax Credit blog post.
How to adjust your W-4 withholding
The IRS replaced the old W-4 format with a new system beginning in 2020. The new W-4 is an attempt to be more accurate in estimating your tax withholding so that you can get closer to owing $0 and getting a $0 refund when you prepare your tax return.
The new W-4 system:
- Aims to reduce the complexity of calculating how much to withhold and increase the transparency and accuracy of the withholding system.
- Uses the same underlying information as the old design.
- Replaces complicated worksheets with more straightforward questions.
It's easy to adjust your withholding. You can do it on paper or electronically. The old-fashioned way is to walk through the worksheets on the W-4 form.
An even easier way is to use the TurboTax W-4 Calculator. This simple tool makes determining your withholdings easy. Just answer the questions and the withholding amount is computed for you.
- If the result from the W-4 calculator is different from your current withholding, ask your employer for a fresh W-4 form to fill out.
- If you're married and both of you work but earn different levels of income, you can use the Step 2(b) — Multiple Jobs Worksheet to calculate how much extra withholding the higher earner will need to withhold in box 4(c).
- The new W-4 also allows you to approximate how much you plan to deduct on your 1040 (either claiming itemized deductions or the standard deduction) and place this in box 4(b).
- Should you have income from other sources (not a job), you can report it in box 4(a) to change how much money your employer withholds from your paycheck.
You can adjust your W-4 at any time during the year. Just remember, adjustments made later in the year will have less impact on your taxes for that year.
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