When you start a new job, one of the first forms you fill out is the IRS Form W-4. This form determines how much federal income tax your employer will withhold from your paycheck. Although it may seem like routine paperwork, it greatly impacts whether you get a refund or owe money at tax time. If you don’t withhold enough taxes, the consequences can include tax bills, penalties, and interest.
Why Are Taxes Withheld from Paychecks?
The U.S. operates on a “pay-as-you-go” tax system. That means taxes must be paid as income is earned, not just at the end of the year. Employers help by withholding income taxes and sending them to the IRS on your behalf. This system helps prevent taxpayers from owing large lump sums come tax season.
How Is Your Withholding Amount Determined?
The amount of tax withheld from your paycheck is based on your Form W-4. Key factors include:
- Your filing status (e.g., single, married filing jointly)
- Number of dependents
- Additional income or deductions
- Whether you have multiple jobs or a working spouse
If your financial situation changes but your W-4 doesn’t, you may not be withholding enough to cover your full tax liability, which could lead to a host of problems.
What Happens If You Withhold Too Little?
- You May Owe the IRS – The most direct result is a tax bill. If too little has been withheld, you’ll have to pay the difference when you file your return. This can be a surprise if you’re used to receiving a refund.
- You Could Be Penalized – If you haven’t paid at least 90% of your total tax liability throughout the year, you might be hit with an underpayment penalty. The IRS may also charge interest on the unpaid amount.
- It Can Impact Your Financial Planning – An unexpected tax bill can throw off your budget. If you don’t have enough saved to cover it, you may have to delay other expenses, incur debt, or face late payment penalties.
If you’re unable to pay your tax balance in full when due, this could also result in collection actions. The IRS may garnish your wages, place a lien on your property, or even levy your bank account.
Steps to Take If You’ve Underpaid Taxes
If you think you’re under-withholding, there are steps you can take to correct the issue.
Use the IRS Tax Withholding Estimator
Use the IRS Tax Withholding Estimator tool to check your current withholding and get a better sense of what changes, if any, are needed.
Submit a New Form W-4
Based on the estimator’s results, you can fill out a new W-4 to adjust your withholding. You might choose to increase withholding or add a specific dollar amount to each paycheck.
Make Quarterly Estimated Payments
If you have additional income not subject to withholding (like freelance work, rental income, or investments), you may need to make estimated tax payments every quarter to avoid underpayment penalties.
Talk to a Tax Professional
If you’re unsure how to calculate your withholding or estimated payments, consider consulting a tax advisor. They can help you create a plan to stay compliant and avoid penalties.
Stay Proactive and Avoid Surprises
Underpaying your taxes can lead to unpleasant surprises, but it’s avoidable with a little planning. Check your withholding annually — especially after life changes like getting married, having a child, or switching jobs. A quick review today can save you from a big headache next April.