How to manage payroll withholding to avoid tax hit

January 19, 2014 

An unexpected bill can throw you into a tizzy at tax time. And if the amount is significant, you could owe underpayment penalties, too. Assuming you’re an employee, you can avoid this unhappy fate next year by increasing the amount of federal income tax withheld from your paycheck. Ask your employer for a new W-4, or download one at www.irs.gov/pub/irs-pdf/fw4.pdf. To increase the amount withheld, decrease the number of allowances. (If you want to have less withheld, add more allowances.) In 2014, each allowance will basically tell your employer to ignore $3,950 of your salary when figuring how much to withhold.

If you experienced a big life change in 2013 (or expect one in 2014), you probably need to update this form. For example, if you get married and one spouse earns significantly more, you will likely enjoy a marriage bonus. However, dual-income spouses who earn about the same amount could end up paying a marriage penalty — which could result in an unexpected tax bill if you fail to adjust your withholding. Same-sex couples who are legally married also might face a marriage penalty.

Having a baby will likely lower your tax bill — and not just because you get to claim an additional dependent, says Jackie Perlman, a tax analyst with H&R Block’s Tax Institute. You probably also will be eligible for tax breaks, such as the child tax credit, that will further lower your tax bill.

If you freelance or plan to start a business on the side, consider decreasing the number of allowances you claim. By increasing your withholding, you might be able to avoid the hassle of paying quarterly estimated taxes on the additional income.

Because withholding is based on annual salary, if you leave the workforce for a few months, you’ll probably have too much withheld when you go back to work, says Bob Meighan, vice-president of TurboTax. Instead of waiting for a refund, adjust your allowances to account for the downtime.

Your tax preparer or tax software program should be able to calculate your withholding. You also can find a worksheet on Form W-4. There’s a separate worksheet for two-earner couples that helps you figure out how many allowances each spouse should claim.

If you received a big refund this year and don’t expect big changes in your financial situation, try our Tax Withholding Calculator at bit.ly/1dNPfVe. Use information from your 2013 tax return to answer three questions, and we’ll estimate how many allowances you should claim. And note that if you show a pattern of underwithholding, the IRS might tell your employer to limit the number of your allowances, Perlman says.

Send your questions and comments to Kiplinger’s Personal Finance magazine senior associate editor Sandra Block at moneypower@kiplinger.com.

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