Is Your Tax Withholding Strategy Hurting You?

By Kelly M. Walsh, Esq.

Many people have strategies for their income tax withholding, or simply fall into a strategy without planning or considering if it is the best approach. Most financial experts recommend withholding exactly the right amount so that you do not owe any taxes at the end of the year and you do not get any refund, or under-withholding so that you are more likely to owe taxes at the end of the year. Of course, you should not go too far with under-withholding, as there are penalties for failure to pay taxes or make estimated taxes throughout the year. It may also be challenging to come up with the taxes due at tax time, leading to more problems down the line.

On the other end of the spectrum, many people choose to over withhold taxes. This means that they look forward to receiving a refund at tax time. I have seen several instances in which people receive thousands of dollars in tax refund. It is exciting to get that much money all at once, but it also means you have been depriving yourself of money to which you are entitled all year long and you missed the benefit of having that money earlier. Some people do not trust themselves to use their own money responsibly, though, and over withhold to force themselves to limit spending and essentially use the government taxing authorities as their savings method.

I recommend considering whether your tax withholding strategy is working for you or against you. If you are keeping up with all obligations throughout the year and your tax refund is used for the type of expenditure that you would save up for, then this withholding strategy may be working for you just fine. Keep in mind, though, that you are giving the government the time value of your money. You could take that time value for yourself. If you did not over withhold, you would be able to transfer that money into an interest-bearing savings account or investment so that you could earn interest, dividends, or capital gains from your money.

If you over withhold and find that you are falling behind on obligations all year, racking up interest and late fees on debts, and hoping against hope that your tax refund will be enough to catch you up again, your withholding strategy is actively hurting you. Under withholding, incurring underpayment penalties with taxing authorities, and finding you cannot afford to pay tax debt on time also actively hurts those who use the opposite strategy.

You can change your withholding by speaking with your employer's personnel or human resources department and asking to complete a new Form W-4. If you withhold too much, you should reduce the number of allowances you claim on this form or remove extra withholding. If you withhold too little and owe penalties or more tax debt than you can catch up at tax time, you should increase the number of allowances or add extra withholding.

If you find that you are struggling with tax debt or other debts, call 717 775 7195 and ask about a consultation with me. We can discuss what approach to resolving your debt is best for you, and what you can do to prevent similar problems in the future.