Federal withholding is based on your filing status, your age, and your annual income. If you are an employee whose employer is responsible for your withholding, the process begins with providing your employer with a form W-4 in January. Documents for filing taxes including earning and withholding information for the previous year must be received by employees and/or contract workers no later than January 31.
If you are responsible for issuing employee W-2’s, expecting a Form 1099 for contract work, or due to being self-employed you are responsible for your full tax liability, you need to plan ahead. If you are an employer, self-employed or a contract worker, you need to know how to calculate federal withholding. If you are an employee your employer is responsible to do correct withholding. You still want to confirm that correct withholding is being done.
How Does My Employer Determine How Much To Withhold
When you are hired you have paperwork to complete which includes an IRS form W-4. The form can also be found on the IRS website. Once you complete the form your employer computes your withholding based on your age, filing status, and the number of dependents indicated on the form along with your expected annual income.
How Can I Know If My Employer Is Withholding The Correct Amount
On the IRS website, you can find a Tax Withholding Estimator you can use to compute if your withholding is correct. If you have a major life event such as a marriage, the birth or adoption of a child, or bought a house you might need to change your withholding. If so, you will need to fill out and return to your employer an updated form W-4.
What Can I Do If My Withholding Is Not Correct
If you go to the IRS website and determine from the Tax Withholding Estimator that what your employer is withholding is not correct you should contact your employer. You will most likely need to complete a new form W-4 and return it to your employer. Be sure to follow up once you have returned the updated form W-4.
What If I Am A Contract Worker Or Self-Employed
The rules are different if you are self-employed. If your net earnings through self-employment are $400 or more you are required to file taxes on those earnings. If you earn less than $400 you may still have to file if there are other circumstances. It might be good to check with a tax specialist for assistance.
If you are self-employed, own your own business, or receive a 1099 statement for contract work, you will need to plan carefully. You will need to estimate your income for the year to determine your tax liability. Plan to pay estimated taxes quarterly to keep from having full liability at the end of the year. You might want to set additional funds aside in order to avoid possible penalties and interest should your earnings substantially exceed your estimate.
Plan to pay taxes on 92.35% of your net earnings. Net earnings are your gross business earnings minus trade and business expenses. Added to your income tax liability is the full self-employment tax of 12.4% of your income for Social Security plus 2.9% for Medicare, or a total of 15.3%. For incomes above a given threshold, there is additional Medicare Tax. The threshold falls above earnings of $250,000 for a married individual filing a joint return, $125,000 for a married individual filing a separate return, and $200,000 for all others.
To help reduce your net business income be sure to keep up with all your paperwork including expenses and income. You will need it to document any allowed deductions. You can also reduce your tax liability by contributing to an IRA.
What Happens If I Underestimate My Withholding
What happens depends on your status. Are you an employee receiving a W-2 at the end of the year? While having less withheld during the year may help your budget, it could cause problems at the end of the year. If you have too little or no withholding for the year you will still need to file taxes. When you do, you will still be responsible for the entire tax liability and may be required to pay at filing if you have the resources to do so.
If you are self-employed, have underestimated your tax liability, and owe more than $1,000 you could be hit with penalties and interest. It is essential that you assess and adjust during the year to avoid that difficulty. There are circumstances which allow the penalty to be waived.
- You owe less than $1,000
- You owed nothing for the previous year
- You paid at least 90% of taxes owed
- Failure to pay was not due to neglect but to underlying circumstances
Is Overestimating My Withholding A Problem
Overpaying taxes during the year may result in a sizable return for you. Consider though that the IRS has interest free use of money that belongs to you. While that refund seems like a good idea, that money could have been in your budget throughout the year or accumulating in your account should an unexpected expense occur.
Whether you are a W-2 employee, or a self-employed or contract worker, care should be taken to do your own research. You should accept responsibility for calculating whether your withholding or quarterly estimated payments are close to what your actual tax liability will be. Keep in mind that life events may mean you should reassess and possibly adjust your withholding.
Tax Crisis Institute has been a tax relief leader for over 30 years. When you work with the Tax Crisis Institute, we’ll make sure you don’t pay anything more than you owe!
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