Tax season is upon us, and now is a great time to review your withholdings. Back when I was in college studying for my accounting degree, I remember one of my tax professors saying that if you relied on a big tax refund every year, you were managing your money incorrectly.
I honestly took offense to this. I depended upon that tax refund every year! How could he say that I was somehow terrible at managing money if I got a big refund every year?! So I walked up and asked him to help me understand his point. I was a couple of years older than most of the kids in the class, and I was already working in an accounting position for a large engineering firm in Atlanta. So I had more of an understanding of trying to pay rent, car payments, and groceries than my peers did.
This professor (a 30-year CPA turned CFP) sat me down and told me that if you consistently get a large tax refund every year, then you’re just giving the government an interest-free loan. That money is yours – it’s why the government gives it back to you in the form of a refund. And if you just change your withholdings, you could add more money to your paycheck every payday.
Figuring out Your Withholdings
I have to be honest. No one raised me to be afraid of taxes, but somehow I took on this fear of owing taxes to the government. Like I was so afraid to owe them money that I intentionally claimed zero when I was single and then continued to claim it even after I was married. This was all done out of fear. Fear of having to owe money or going to jail.
Now, granted, back then, I wouldn’t have had money to pay taxes if I had owed it, but the point is I was letting fear dictate how I managed my money. I was struggling financially, and there was a simple fix – fix the W-4.
If you receive a normal paycheck, you more than likely completed a W-4, and on this W-4, you claimed a few things. And everything you put on that form dedicates how much is taken out for taxes. So if you are consistently getting $1,000 or more every refund you very likely are not claiming correctly on your W-4. You could keep so much money every paycheck (and maybe get ahead financially if you aren’t already).
To figure out your withholdings, go to the IRS website here and use their calculator to figure out what your withholdings should be. Walk through the steps (you will need your most recent paycheck stubs to complete the steps). This will tell you what you should be claiming on your W-4.
Why You Should Update Your Withholdings
If you go through the IRS calculator and realize that you need to change your withholdings contact your HR department and update it. Doing this will allow you to keep more of your hard-earned money every paycheck. Yes, it will mean that you will probably not be getting those huge refunds every year, but that’s okay. You’re now going to have more money to live on throughout the year. And with inflation affecting our food prices and everything in between who couldn’t use a little extra pocket change?
Could it also mean that you could potentially owe the IRS money? Of course. Believe it or not, this is always a reality. You could owe the IRS and not realize it until tax time, no matter what you’re withholdings are.
Emergency Fund is your Lifeline
And that brings me to my last point. You absolutely must have an Emergency Fund. It will not only protect you in the event of an emergency, but it can also pay a massive tax bill. (I go into more detail on setting up an Emergency Fund and learning the basics of money management in my book Getting Good with Money) This is crucial if you are self-employed as well. Trust me, my husband is self-employed, and we know firsthand what it’s like to pay a massive tax bill. And if you are self-employed, look into not only filing an LLC but also becoming an S Corp. This will require you to run payroll but you will avoid paying the self-employment tax which is currently 15.3% for federal.
Either way, you need to make sure that you have an Emergency Fund that can cover whatever life (or the IRS) throws at you.
Should you pay for a CPA?
Okay, one last thing. There were many years that I did our taxes for free or less than $100 myself through TurboTax (who I love BTW). But over the more recent years, our taxes got a lot more complicated after my husband started his business. So even though I could do our taxes myself, we still choose to pay a CPA to do them for us.
So should you pay for a CPA? Well, that’s entirely up to you and your comfort level. There’s nothing wrong with doing your taxes yourself, especially if your taxes are pretty simple. But there’s also nothing wrong with paying a CPA to do them, either. Just budget accordingly, and if you haven’t seen my post here, where I go in-depth on organizing your taxes, make sure to check it out. Not only will it help you if you are doing your taxes yourself (no more hunting and trying to find stuff!), but it will also keep a CPA bill down. It will lower the overall work in verification that your CPA will have to do, thus saving you money.
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