Are You Withholding Enough? Adjustments to Make Before the Year Ends
As the year winds down, it’s the perfect time to evaluate your tax withholding and estimated payments to ensure you’re on track. While it may not seem urgent now, underestimating your tax liability could lead to penalties, interest, or a hefty bill come filing season. On the flip side, overpaying means you’re essentially giving the government an interest-free loan.
In Week 4 of our 6-part series on preparing for the 2024 year-end tax season, we’re focusing on why reviewing your withholding and estimated tax payments now can save you headaches later. Let’s dive into actionable steps to ensure your tax payments align with your actual liability.
Understanding Tax Withholding
Your withholding is the amount of federal, state, and sometimes local taxes your employer takes out of your paycheck and sends to the government. This amount is determined by the information you provide on your W-4 form and is meant to cover your tax liability throughout the year.
Why It Matters
Underwithholding: If too little is withheld, you’ll owe taxes when you file, potentially with added penalties for underpayment.
Overwithholding: If too much is withheld, you’ll receive a refund, but you’ve effectively loaned your money to the government.
How to Check Your Withholding
Use the IRS Withholding Estimator
The IRS provides an online Withholding Estimator to help you determine if you’re on track. You’ll need:Your most recent pay stub.
A copy of last year’s tax return for reference.
Estimates of other income sources, deductions, and credits.
Review Your W-4 Form
If adjustments are needed, you can update your W-4 with your employer. Here’s what to look for:Claim Dependents: Ensure your dependents and credits are accurately reflected.
Extra Withholding: If you anticipate owing taxes, you can request additional withholding on the W-4 form.
What Are Estimated Tax Payments?
Estimated payments are quarterly payments made directly to the IRS (and often state governments) to cover taxes on income not subject to withholding. This applies to:
Self-Employed Individuals: Taxes aren’t withheld from freelance or gig income.
Investors: Capital gains, dividends, or interest income often require estimated payments.
Side Hustlers: If you have a side gig alongside a W-2 job, withholding from your paycheck may not cover the additional income.
How Estimated Payments Work
The IRS requires taxpayers to pay at least:
90% of this year’s tax liability, or
100% of last year’s tax liability (110% for higher-income earners).
Failing to meet these thresholds can result in penalties.
Steps to Evaluate Your Estimated Payments
Calculate Your Taxable Income
Add up all income sources, including wages, self-employment earnings, rental income, and investments. Subtract deductions to estimate your taxable income.Estimate Your Tax Liability
Use the IRS tax brackets and credits applicable to your situation to estimate how much you’ll owe for the year.Check Payments Made So Far
Review your:Federal withholding amounts from paychecks.
Quarterly estimated payments already submitted.
Determine Additional Payments
If there’s a shortfall, you can make an additional estimated payment before the year ends to avoid penalties.
Why Adjusting Regularly Is Crucial
Avoid Penalties and Interest
The IRS imposes penalties for underpayment of estimated taxes or insufficient withholding. These penalties are calculated quarterly, so making adjustments regularly can reduce or eliminate what you might owe.
Plan for Your Budget
Knowing where you stand helps you avoid surprises during tax season. It also allows you to plan for any remaining tax payments without disrupting your budget.
Take Advantage of Timing
The sooner you adjust your withholding or submit estimated payments, the easier it will be to manage your cash flow while staying compliant.
How to Adjust Withholding or Make Payments
Update Your W-4
If you’re employed, submit a new W-4 to your HR department to adjust your withholding. You can request additional withholding on line 4(c) of the form if you expect to owe more than what’s currently being withheld.Submit an Estimated Payment
Use IRS Form 1040-ES to calculate and submit your payment electronically through the IRS website or by mail.Automate for 2025
If you find you’ve underpaid this year, set up automatic estimated payments for the upcoming year to stay ahead of your tax liability.
Special Considerations for Small Businesses
If you’re a small business owner, your tax situation may involve complexities such as payroll taxes, self-employment taxes, and business deductions. Here’s how to stay on top of your obligations:
Track Income and Expenses: Use bookkeeping software to monitor your cash flow and calculate your taxable income accurately.
Set Aside Taxes: Regularly set aside a percentage of income for taxes, so you’re prepared to make estimated payments.
Review Payroll Withholding: If you have employees, ensure payroll taxes are accurate and submitted on time.
Final Thoughts
Regularly evaluating your withholding and estimated payments can save you from penalties and a stressful tax season. A little effort to review your situation before the end of the year can ensure you’re paying the right amount—not too much, not too little.
At On Target Tax Services, we specialize in helping individuals and small businesses stay tax-compliant while minimizing their liabilities. If you need assistance reviewing your withholding, calculating estimated payments, or preparing for tax season, contact us today.
Stay tuned for Week 5 in our series, where we’ll focus on “Year-End Tax Preparation Tips for Small Businesses.”
