Finance

What Families Often Get Wrong About Tax Withholding

Finance Editorial Team Staff Writer · May 8, 2023 · 5 min read
What Families Often Get Wrong About Tax Withholding

Photo: everyday-trends.com editorial

Explains how W-4 withholding works, why large refunds are not necessarily a win, and when it may be worth reviewing your withholding settings.

Key Takeaways

  • A large tax refund means you overpaid the IRS during the year, not that you earned a bonus.
  • Major life changes like marriage, a new child, or a second job require a W-4 update.
  • Underwithholding can trigger IRS penalties if you owe more than $1,000 at filing.
  • The IRS Tax Withholding Estimator is a free tool that helps you calibrate your W-4 accurately.
  • Withholding is general financial information; a tax professional can advise on your specific situation.

Why withholding trips up so many households

Tax withholding is the amount your employer sends to the IRS from each paycheck on your behalf. You set it using Form W-4, the Employee's Withholding Certificate. Get it right and your tax bill at filing is close to zero. Get it wrong in either direction and you either hand the government an interest-free loan all year or face an unexpected bill in April.

Most families fill out a W-4 once when they start a job and never look at it again. Life changes constantly, but withholding settings often do not. That gap is where most mistakes live.

1

Treating a tax refund as a financial win rather than an overpayment.

Why it happens: Refunds feel like a bonus because they arrive as a lump sum, and most people associate receiving money with something positive.
How to avoid: Recognize that a large refund means your paychecks were smaller than they needed to be all year. Use the IRS Tax Withholding Estimator (available free at irs.gov) to bring your withholding closer to your actual liability.
2

Never updating the W-4 after a major life change.

Why it happens: Most employers only prompt employees to fill out a W-4 at hiring. After that, it requires the employee to initiate a change, and many people simply forget.
How to avoid: Build a habit of reviewing your W-4 after any significant life event. Request a new form from your HR department or payroll system, complete it with updated information, and submit it promptly.
3

Assuming the default withholding setting is always accurate for a two-income household.

Why it happens: Each employer withholds based only on the salary it pays, with no visibility into a spouse's income. This causes both employers to under-withhold relative to the household's combined tax bracket.
How to avoid: Complete the Multiple Jobs Worksheet on the W-4 or use the IRS Withholding Estimator with both incomes entered together. Adjust withholding at one or both jobs to cover the combined liability.
4

Underwitholding to maximize take-home pay, then facing a penalty at filing.

Why it happens: Some households deliberately claim extra allowances to keep more money in each paycheck, not realizing the IRS charges an underpayment penalty when the amount owed at filing exceeds $1,000.
How to avoid: If you reduce withholding, verify that your payments throughout the year will cover at least 90 percent of your current-year tax liability or 100 percent of the prior year's liability (110 percent if adjusted gross income exceeded $150,000). A tax professional can help you calculate the safe-harbor thresholds for your income level.
5

Forgetting to account for self-employment or gig income on the W-4.

Why it happens: Households that rely on a W-4 job for most income sometimes treat side income as separate, not realizing it adds to total taxable income and can push the household into a higher bracket.
How to avoid: Use the Other Income line on the W-4 to include expected non-wage income, or make quarterly estimated tax payments to cover the additional liability. Mixing both strategies is also possible depending on your situation.

What a big refund actually means

A refund feels like found money, but it is your own money returned without interest. In practical terms, a $3,000 refund means you sent the IRS about $250 extra per month that you could have kept in your paycheck, used to pay down debt, or placed in a savings account earning interest.

$3,081

Average federal tax refund (IRS, 2023 filing season)

IRS filing season statistics for 2023 showed the average refund was approximately $3,081, representing substantial overpayment by millions of households.

$1,000

Threshold that triggers IRS underpayment penalty

The IRS generally charges an underpayment penalty when a taxpayer owes more than $1,000 at filing and did not meet the applicable safe-harbor payment thresholds during the year.

This does not mean aiming for a large refund is irrational. Some households use overwithholding as a forced savings mechanism, and that is a personal choice. The problem is when families believe the refund is a reward for good tax planning rather than a consequence of overpayment. Understanding what it actually is lets you decide whether the tradeoff suits your budget.

When to revisit your W-4

The IRS recommends checking your withholding whenever a significant life event occurs. Common triggers include:

  • Getting married or divorced
  • Having or adopting a child
  • A spouse returning to or leaving the workforce
  • Taking on a second job or significant freelance income
  • A major change in salary or bonus structure
  • Buying a home and gaining a mortgage interest deduction

Two-income households with similar salaries face a particularly common trap. Each employer withholds as if that salary is the household's only income, which can leave the combined income under-withheld by a meaningful amount. The W-4 has a specific section for this scenario, called the Multiple Jobs Worksheet, that produces a more accurate withholding amount.

This article is for general informational purposes only and is not tax or legal advice. Consult a licensed tax professional for guidance specific to your situation.

Finance Editorial Team

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