“The power of understanding your withholdings is peace of mind—no surprises come tax time.” - Radon Stancil
Do you like surprises? Maybe a surprise birthday party or an unexpected bonus? Those can be great surprises! But a bad surprise is when your CPA calls and says something like this:
“John, I’ve completed your tax return, and you didn’t withhold enough for taxes during the year. You owe $10,000.”
John is blindsided as he did not plan for this expense.
With interest rates increasing over the last few years, underpayment penalties have also risen. The current interest rate on underpayments is around 7%. These penalties are calculated based on the amount underpaid, the time it occurred, and the current interest rate. In the example above, part of the $10,000 John owes includes penalties for under-withholding during the year.
Here are five reasons to review and potentially adjust your tax withholdings for 2025:
- You owed a significant amount in taxes last year.
If you found yourself with a hefty tax bill when you filed last year, it’s a clear indicator that you need to review your withholding and potentially increase it.
- Your marital status changed.
Marriage or divorce can dramatically affect your tax situation, as it changes your filing status. Married filing jointly typically provides a more favorable filing status than single. If you got married or divorced, you may need to update your W-4 to reflect your new status to ensure the correct amount is being withheld.
- You experienced unemployment.
Periods of unemployment can disrupt your withholding strategy. For instance, a client who was unemployed for the first three months of the year assumed he could withhold less once he found a job. By year’s end, he realized he wasn’t withholding enough. Don’t let temporary unemployment lead to an unexpected tax bill.
- You started receiving vested restricted stock units (RSUs).
RSUs are taxed as ordinary income when they vest. Employers typically withhold taxes at 22% for income up to $1 million and 37% for income above that threshold. However, if you’re in a tax bracket higher than 22%, automatic withholding may not be enough. Depending on the value of your RSUs, this could result in an unwelcome surprise at tax time.
- You had a baby.
The birth of a child brings not only joy but also a tax benefit. Parents can claim a $2,000 tax credit for each child under 18, provided they meet eligibility requirements and have an annual income below $200,000 (single) or $400,000 (joint). If this applies to you, consider adjusting your withholdings to account for the credit.
Avoid Surprises and Gain Peace of Mind
Adjusting your withholdings isn’t a set-it-and-forget-it task. An annual review can help you avoid unwanted surprises and provide peace of mind. Reviewing your withholding is something we assist our clients with. It’s part of a sound tax planning strategy.