IRS bills can sometimes be a shock, but Yahoo Finance reporter Rebecca Chen joins Wealth! to help filers manage their tax withholdings, avoid surprises, and save money in the process.
Chen explains that a tax withholding is a prepayment Americans make throughout the year to the government for their expected tax liability. At the end of the year, a W2 tallies up all the prepayments, and if the total amount is less than needed, the filer will have a tax bill. The trick, Chen explains, is to think about your withholding goal.
“Having a refund isn’t always a good thing; it just means you gave the IRS an interest-free loan throughout the year,” Chen says. A more profitable strategy might involve setting your withholdings aside in a high-yield savings account and earning interest on your tax liability.
For more expert insight and the latest market action, click here to watch this full episode of Wealth!
This article was written by Gabriel Roy.
Video Transcript
– So you’re finally getting around to filing your taxes and you get smacked with a surprise bill from the IRS. That money you thought you had saved for a summer vacation gone. To help with some guidance on managing your tax withholdings so you have no more surprises next tax season is our very own Rebecca Chen. Set us up for the 2025 filing season that looks back at 2024, Rebecca.
REBECCA CHEN: So tax withholding is something that I think everybody is fairly familiar with. But I do want to go back and touch on the basics of what exactly it is so you can get it right in the future or there are no surprise bills, as you just mentioned, for the future. Really, how a CPA explained this to me is that tax withholding is a prepayment that you pay to the government for your taxes throughout the year.
So every period, out of your paycheck, you pay a little bit of tax withholdings to the government. And at the end of the year, your W-2 tallies that up. And it tells you how much you have in your withholding or how much you prepay in your taxes.
Now, if you have more prepayment than you need, you get a refund. But if you have less, then you get a tax bill. So in order to avoid any surprises, the trick isn’t to over withhold or under withhold. The trick is to know what you want to withhold.
And what I mean by that is, when you’re sitting down and looking at your income for the year for the year to decide how much you want to withhold, think about what is your withholding goal. Now, I know that sounds completely weird. Why would you have a goal for withholding?
But think about if you want to have a refund, if you want to owe taxes, or do you want to break even throughout the year? Intuition will come to you and say, I want a refund. But having a refund isn’t always a good thing. When you have too much refund, it just means that you gave the IRS an interest-free loan throughout the year.
And that comes to– and then my next point is what if you want to owe money? If you owe money, not only does it mean that you didn’t give the IRS a interest-free loan, but you could actually use that withholding that you were supposed to prepay them, put it in a high yield saving account and earn some interest.
So by the end of the year, take that money out to pay the IRS for your tax liability, and you also earn some interest throughout the year. So really think about what is your goal. Now one way isn’t always necessarily better than the other because if you have some tax refund, it could just be a good way to save because for you personally, if you want to save, you want to have a forced saving.
So really, the trick to not having a surprise during tax season is not having to pay or getting a refund, but it’s really knowing exactly where you sit based on how you set up your goal at the beginning of the year.
– So, Rebecca, when should you consider adjusting your withholdings and how do you go about doing that?
REBECCA CHEN: This is a great question. Withholding is both an art and science. And knowing when to– knowing when to adjust it, it’s not always so clear. But just know that if you have some major life event happening– and by major, and these can be very personal.
Like, did you get married? Did you get divorced? Did you have a kid? All these things will impact your taxes. So when you have these things happening throughout the year, these are the times that you probably want to look at your withholdings.
Other financial happenings in your life can also trigger you to want to change your withholding, and that includes, did you buy a house? Did you sell a house? Did you sell any cryptocurrencies and make a lot of money? I hope you did.
And because if you did, you may want to look at your withholding again and see if that is worth updating. And most people actually then most people will think about, OK, I don’t even know. It just comes out of my paycheck. Where do I even go to change something like that?
Just talk to your HR department. Ask them for a W-4, which is a withholding form and update from there. You can update this anytime during the year because it’s your money. And make sure you’re just making sure that you’re not surprised at the end of the year whether you’re over withholding or underwithholding.
– Yeah, Rebecca. I’m very much just waiting for that checkbox to appear on the paperwork that says or asks, do you co-parent a pet because cats are expensive. All right, Rebecca. Thanks so much. Appreciate it.