Taxes 101: Are You Withholding Enough?
For the second year in a row, Christina Routon and her husband owe federal and state taxes, despite adjusting their withholding last year. “We’re looking at paying about $1,000 in federal and $500 to the state of Alabama,” says Routon, 42, who lives in Opelika, Ala. “We’ll need to adjust again for 2014.”
If you’re staring down the barrel of a large tax bill this year, it may be time to ask yourself: Are you withholding enough? In other words, is your employer holding enough taxes out of your paycheck to satisfy what you owe the IRS each year? Unless your tax bill is due to some surprise income last year—you got a bonus, for instance, or received an inheritance—the answer is probably no.
Should You Withhold More?
Ideally, tax professionals want to see you get money back. In 2013 the average tax refund was more than $2,600, according to the IRS. But that may be a little on the high side. “I like for people to hit about $1,000 in refunds,” says Bob Wheeler, a CPA in Santa Monica, Calif., and author of “The Money Nerve: Navigating the Emotions of Money.” “That gives me a little bit of a cushion if they forget about an extra bit of income they forgot they had. I don’t like them to owe anything.”
Think about it this way: If you wind up getting a big refund, that probably means you were paying the government too much, and that money could have been earning interest throughout the year, if you were able to invest it. However, some people prefer to get a refund, because they might have otherwise spent—not saved, or invested—the cash. On the other hand, owing a big sum of money at year’s end isn’t pleasant, especially when many Americans don’t have adequate emergency savings. Your best bet is to consider adjusting your withholdings so you come out more or less even.
Of people who filed tax returns in 2013 that were processed, slightly more than one in five owed money. If you owe more than $1,000 (or you’d rather not owe at all), it’s probably time to go back to the drawing board. You can do this in two ways. First, do you have an accountant? That should be your first step—particularly if you are in a slightly less basic tax situation, such as making some freelance income. “If you’ve got multiple things going on, it probably makes sense to get with a tax adviser to project out next year’s tax,” Wheeler says.
To DIY—or Hire an Accountant?
It’s also a good idea to check with your accountant regarding tax law changes, which may make it difficult to use last year’s tax liability as an estimate. This is especially true if you’re a high earner. “For our clients who are in the higher tax brackets, we recommend that they meet with us and their CPA each year in the October to December time frame to do a tax projection, so there are no major surprises when they file their return,” says Bill Cleveland, a CPA and financial adviser in Augusta, Ga. “And it still gives them time to do some tax planning before year-end.”