Were you disappointed with the size of your tax refund this season? Your W-4 payroll withholding selections could be the difference between a big refund, small refund, or owing the IRS.
“Tax refunds are simply an early overpayment, but some taxpayers believe that a refund is great,” Daniel Morris, senior partner at Morris + D’Angelo CPAs, told Yahoo Money. “People use refunds for property tax payments, vacations, and large purchases.”
Marriage, divorce, childbirth, adoption, and buying or selling a home are all reasons to revisit your W-4 payroll withholdings.
For some taxpayers, changing your W-4 withholdings can lead to a bigger refund next tax season. The question comes down to whether you want more money in your paycheck throughout the year or a big tax refund at tax time.
Pandemic relief affected this year's refunds
Unlike previous tax seasons, pandemic tax relief efforts affected the size of some tax refunds.
Due to the pandemic, the first $10,200 in unemployment benefits collected in the tax year 2020 were not subject to federal tax. That didn’t happen this tax season so people may have had smaller refunds or owed Uncle Sam, thinking the same provision would be in place.
Additionally, in 2021 “taxpayers who didn’t opt out, received advanced monthly CTC payments throughout the year instead of the end of year, making refunds smaller,” Joanna Ain, associate policy director at Prosperity Now, told Yahoo Money.
Some taxpayers may have seen larger refunds this year after key changes from pandemic-era tax legislation qualified them for credits they previously weren't eligible for in previous years, such as the Child and Dependent Care Credit and the Earned Income Tax Credit.
Adjusting your W-4 withholdings is only part of the equation
If you like the anticipation of a bigger refund, the IRS has a calculator that helps you estimate the amount of money you need to have withheld from your paycheck to get a refund size of your choice next tax season. The tool takes into account your expected W-4 income (including expected bonuses), income from other sources, and credits and deductions you take.
The process is involved and requires you have the following documentation to complete:
Paystubs for all jobs (including your spouse's)
Other income info (side jobs, self-employment, investments)
Most recent tax return
Adjusting your payroll deductions can help increase or decrease your refund during tax season, but it's not a perfect tool. (Check the FAQs for more help.)
“Changes to income, investments, pay raise, job change, part-time work, college graduation, death, marriage, birth, home purchase or selling, rental property are all reasons to reach out to a tax professional,” Larry Gray, CPA at AGCCPA and government relations liaison for the National Association of Tax Professionals (NATP), told Yahoo Money. “These have tax implications and changing your W-4 alone is probably not the best indicator.”
Getting divorced will have tax implications beyond simply adjusting your W-4. Additionally, retirees with pensions or those with complex tax situations with alternative minimum tax, long-term capital gains, or qualified dividends may not find the tool useful.
“Working multiple jobs, e-commerce income from eBay or Etsy, gig work with Uber or Doordash, and social media revenue, makes filing low-to-moderate income tax returns complex to determine whether they qualify for credits and deductions like business deduction for mileage and home-office,” Gray said.
If you work multiple jobs, do gig work, receive 1099s for income or social media revenue, then adjusting your W-4 becomes more complicated because there may be other taxes like FICA and Medicare taxes that the tool doesn't take into account.
A larger federal refund may cause you to owe state taxes
Unfortunately, making changes to your W-4 for federal taxes for a bigger refund doesn’t always translate to a larger refund for your state taxes.
“The real challenges are with state withholding tables that frequently do not integrate into the federal system and people receive a refund from the IRS, but owe state taxes," Morris said. "And taxpayers find this frustrating."
Ronda is a personal finance senior reporter for Yahoo Money and attorney with experience in law, insurance, education, and government. Follow her on Twitter @writesronda