Clients never like to be surprised by an unexpected tax bill. Even large refunds aren’t ideal because they usually mean your client overpaid during the year. As a tax professional, you can help your clients avoid both scenarios by ensuring their IRS tax withholdings stay accurate throughout all their major life and income changes. This guide covers the most common situations that require a tax withholding adjustment and provides practical tips for helping clients understand when and how to update their Form W-4.
The most common reasons to adjust federal tax withholdings
Clients may need to update their federal tax withholdings whenever a change in their income, employment status, or family situation affects their overall tax liability for the year. Some of the common reasons for adjusting tax withholdings include:
- Job change
- Retirement and pension income
- Investment income and capital gains
- Birth or adoption of a child
- Marriage or divorce
How job changes impact tax withholdings
Changes in income are the most frequent reason your clients will need to adjust their tax withholdings. Whenever a client starts a new job, they must complete a new Form W-4 with their employer. However, this form only reflects income from that employer; it doesn’t automatically consider what they made earlier in the year.
If the new job pays significantly more than their previous job, they may need to make extra withholding on their W-4 on line 4(C) of the form to make up for the difference.
Adjusting withholding for multiple jobs or side income
Clients with more than one job, or those who earn freelance, gig, or self-employment income, frequently under-withhold. For example, a client working full-time while doing graphic design work on the side may owe additional tax unless they increase withholding at their full-time job. When in doubt, the IRS Tax Withholding Estimator can help determine accurate withholding amounts based on prior wages, year-to-date withholding, and projected income.
Form W-4 instructs taxpayers to use the Withholdings Estimator if they:
- Expect to work only part of the year
- Have dividend or capital gain income or are subject to additional taxes, such as Additional Medicare Tax
- Have self-employment income or
- Prefer the most accurate withholding for multiple job situations
Clients who lose their job or receive workers’ compensation, qualifying disability income, or other nontaxable benefits generally have no withholding requirement because these payments are typically not subject to federal income tax. They’ll likely have an exemption from withholding on their W-4.
How retirement and pension income affects tax withholdings
Retirement often brings major changes to a taxpayer’s income. Pension payments, Social Security benefits (if taxable), and distributions from retirement accounts such as 401(k) and traditional IRAs may all require withholding. Retired clients can adjust withholding on:
- Form W‑4P for pensions and annuities
- Form W‑4R for most IRA and retirement plan distributions
Encourage clients to adjust withholding when their retirement income changes, or when they begin receiving Required Minimum Distributions (RMDs).
Withholding considerations for investment income and capital gains
Investment income, including dividends and capital gains, is subject to federal income tax and may be subject to state income tax. If a client experiences a large capital gain, like selling a rental home, or liquidating appreciated stock, they may need additional income withholding or estimated tax payment for the year.
High-income taxpayers may also owe the Net Investment Income Tax (NIIT), a 3.8% surtax on certain investment income once income exceeds applicable thresholds. Accounting for investment income is important to avoid underpayment penalties and ensure accurate tax filings.
Adjusting tax withholdings after giving birth to or adopting a child
Expanding a family usually entitles the taxpayer to additional credits, such as the Child Tax Credit or the Child and Dependent Care Credit, . Updating the W-4 is simple; the parent should file a new Form W-4 and include the new dependent in Step 3. Adoptive parents may qualify for additional tax credits, including the Adoption Credit, which may lead to further adjustments.
Updating tax withholdings after marriage or divorce
Marriage or divorce often affects filing status, tax brackets, and eligibility for credit. Clients should immediately reexamine their withholdings update their Form W-4 based on their new filing status to avoid withhholdning inaccuracies. Even if a couple gets married late in the year, the IRS treats them as if they were married the entire year. The IRS Tax Withholding Estimator can help new couples calculate withholding based on combined income.
Similarly, clients who are getting divorced should update their tax withholding if the divorce is finalized by the end of the year, and they should consider how dependents will be claimed on future tax returns.
Tips to help tax clients make effective withholding adjustments
Many clients are unaware that major life changes require updated tax withholdings. Proactively educating clients can prevent surprises at a tax time. Considering using the following methods to educate your client base:
- Email reminders
- Social media content
- Website articles
- Postcards or direct-mail notices
This communication can be as complex as an in-depth email series on situations that require adjustments or as simple as a few lines on a postcard.
Whenever you learn about a client’s upcoming life change like job transitions, marriage, new dependents, or retirement, remind them to update their W-4 right away.
W4 withholdings FAQs
What is extra withholding on a W4?
Extra withholding on a W-4 form is an optional amount your client can specify for their employer to withhold from each paycheck for federal income tax purposes. This is calculated based on their allowances and filing status. Clients with changes in life circumstances that impact their annual income, like the sale of stock or a vacation home, may want to elect extra withholding on their W-4 to avoid paying additional taxes and penalties on their annual tax return.
Who is exempt from W4 withholding?
To qualify for exemption from W-4 withholding, your client must have no federal income tax liability in the previous year and expect no federal income tax liability in the current year. While no federal income tax would be withheld in such an instance, your client’s paycheck (if they have one) would still be subject to Social Security and Medicare taxes.
How much federal withholding should be taken out?
To help determine how much federal income tax should be withheld from your client’s paycheck, you’ll want to consider the following:
- The number of allowances they are claiming
- Potential income sources other than W-2 employment, like investments or freelance income
- Whether or not they owed taxes the previous year and how much
- The calculation from the IRS Withholding Calculator
By proactively guiding your clients in adjusting their tax withholdings, you can significantly improve their year-end tax experience. Accurate withholding not only prevents unexpected tax bills but also minimizes the need for estimated tax payments. For more information on how to adjust tax withholding and other common tax preparer questions, visit our tax preparer resources online.
