It’s Time for a Withholding Check Up by Joanie B. Stein, CPA
Posted on January 13, 2022
Preventative care is critical to averting serious (and often costly) emergencies. Just as annual medical exams can help to prevent disease, regular check-ups with your accountants and advisors can help you avoid surprise tax bills and penalties come the April tax return-filing deadline.
Under the U.S.’s pay-as-you-go system of taxation, individuals are required to pay most of their taxes during the year as they receive income. For example, if you are a salaried employee earning W-2 wages, your employer will automatically withhold federal income tax from your pay based on the information you provide on Form W-4, Employee’s Withholding Certificate, including your filing status (single or married filing jointly), the number of dependents under age 17 living with you for most of the year and whether you have more than one job. By contrast, self-employed taxpayers and those whose businesses are structured as passthrough entities (i.e. S corporations and partnerships) will generally pay quarterly estimated tax liabilities for the year in April, June, September and January.
One benefit of regular withholding check-ups before the end of the year is to confirm that you are paying the government your fair share of taxes and are not left will an unexpected tax bill when you file your tax returns. Following are some withholding considerations individuals should address with their advisors and accountants during a mid-year tax check-up.
My Lifestyle Changed Significantly or I Expect a Significant Change to my Lifestyle in the Year Ahead
It is likely that your family and financial circumstances will change throughout the course of your life. When these life events occur, they will often impact your tax liabilities. Therefore, consideration should be given to updating your W-4 when you get married or divorced, you have a child, you buy a house, you get a big raise or you get a pay cut, your work schedule significantly increases or decreases, you or your spouse do freelance work on the side, or you have a lot of unearned income (i.e., dividends, interest, capital gains, etc.).
I am a Salaried Employee who Receives a W-2
Salaried workers must complete IRS Form W-4 to help their employers calculate how much taxes to withhold from their wages and pay on their behalf directly to the government. The amount withheld will depend on various factors, including the employee’s taxable earnings, marital status, number of dependents, and the credits and deductions to which he or she may be entitled. While a W-4 is required for all new employees, workers can update these forms anytime during a year to reflect changes in their lives, such as a new marriage, a divorce or the birth of a child, which, in turn, may affect their withholding amount.
If you are a salaried employee who also has unearned income from investments, rental property, a second job or other non-wage sources, you may elect to have your employer withhold additional tax from your paycheck to reduce your risk of an unexpected tax bill. However, if your employer withholds too much tax from your paycheck, you may be entitled to a tax refund. As exciting as it may seem to receive money back from the government, you should remember that a refund is essentially a return of the money you willingly loaned to the government, interest-free, the prior year.
I am an Independent Contractor who Receives a 1099
Independent contractors, also called freelancers or gig workers, bear the responsibility for reporting and paying taxes on all income they earn, including earnings received in cash, less any deduction or credits to which they may be entitled.
Under most circumstances, if you qualify as an independent contractor, you should consider pre-paying your income and self-employment (Social Security and Medicare) tax liabilities by making four quarterly estimated tax payments directly to the IRS in April, June, September and January. Alternatively, if you also have a salaried job, you may elect to update your Form W-4 to have your employer withhold additional tax from your paycheck to account for the untaxed income you earn as an independent contractor.
I am a Self-Employed Owner of a Pass-Through Business
Income earned by pass-through businesses organized as S Corporations, partnerships, LLCs and sole proprietorships typically flows directly from the businesses to their individual owners, who pay the resulting income tax liabilities and self-employment taxes, if applicable, at their individual income tax rates. However, as a business owner, you may be able to deduct certain expenses from your gross income and ultimately reduce the amount of tax you owe.
For example, under tax reform introduced in 2018 by the Tax Cuts and Jobs Act (TCJA), owners of domestic pass-through businesses may be able to claim a 20 percent deduction on certain qualified business income (QBI). Meeting the eligibility requirements for this deduction depends on a taxpayer’s line of business, the type and amount of income they earn, as well as the amount of W-2 wages the business pays to employees and the depreciable income-producing property it owns. Due to the complexity of this provision of the tax law, it behooves owners of pass-through businesses to speak with their tax advisors and accountants to ensure they implement appropriate strategies to meet their unique circumstances and maximizes their potential tax savings.
I Typically Itemize Deductions on my Tax Returns
Qualifying taxpayers generally have an option to either claim a standard deduction that automatically reduces the amount of income subject to federal taxes or they may itemize their deductions when the total value of their deductible expenses exceed the standard deduction, which for 2021 is $12,550 for single taxpayers and $25,100 for married taxpayers filing joint tax returns. For tax year 2022, the standard deduction increases to $12,950 for single filers and $25,900 for married coupled filing jointly.
It is important to make note of these deductible expenses, many of which are subject to limitations and possible termination under proposed tax reform. For example, under current law, individual taxpayers may not deduct moving expenses; fees paid to legal, tax and financial advisors; or theft and casualty losses that occur outside a federally declared disaster area. In addition, congressional lawmakers are currently considering raising the $10,000 limit on the amount of state and local taxes you may deduct on your federal tax returns. With changes to tax laws, your ability to qualify for itemized deductions may also change and serve as reminder to update your W-4.
About the Author: Joanie B. Stein, CPA, is an associate director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where she works with individuals and closely held businesses to implement sound strategies that are intended to preserve wealth and improve tax-efficiency. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or at firstname.lastname@example.org.