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By Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension, [email protected]

February is a “teachable moment” for military financial service professionals to “talk taxes” with service members. W-2 forms and statements from financial institutions have started to arrive and many people are looking forward to receiving an income tax refund.

Photo by stevepb via Public Domain CC0

Photo by stevepb via Public Domain CC0

Many people deliberately have extra federal and state income taxes withheld from their paychecks. Advantages of over-withholding are that there’s no access to this money and, therefore, it can’t be spent recklessly, and the refund makes a nice windfall once a year to pay off debts or buy “big ticket” items. Disadvantages of big tax refunds are that taxpayers must wait to collect their money and the government pays no interest.

Perhaps the biggest disadvantage, however, of over-withholding is the risk of having a tax refund delayed as a victim of tax identity theft. This happens when fraudsters use stolen personal identification information (e.g., name and Social Security number) to file a fraudulent tax return claiming a fraudulent refund.

Victims can wait months for their money as they take steps to file paperwork to verify their identity with the IRS. Tax identity theft is the most commonly reported type of identity theft according to the Federal Trade Commission (FTC), with more than $5.8 billion in fraudulent refunds cited in a government GAO report.

A small refund, say $500 or less, may be fine, but if when people get back a lot more, they are losing foregone interest on money that could have been saved. They also run the risk of having to wait for a large sum of money if they are an identity theft victim. Social Security numbers are often obtained illegally through database hackings that people have no control over.

The amount of the income tax withholding is based on the number of allowances that a person notes on a W-4 form that is filed with their employer. Essentially, if income taxes are over-withheld, a paycheck is smaller, and a tax refund is larger. In simple terms, tax withholding can be explained this way:

  • More withholding = Smaller paycheck = Larger tax refund
  • Less withholding = Larger paycheck = Smaller tax refund or taxes owed to the IRS

W-4 forms are typically required the first day on a job. The Employee’s Withholding Allowance Certificate section on the bottom of the W-4 form tells employers how much tax to withhold based on a formula from the IRS. Anyone can change their W-4 form periodically with their employer and undo their over-withholding.

Just be careful not to overdo it. Essentially, taxpayers must pay 90% of their current year tax liability to avoid a penalty plus interest. However, there is a “safe harbor” exception rule: no penalties are due if a taxpayer paid at least as much (i.e., 100%) of their prior year’s tax bill (i.e., the tax due shown on their prior year’s tax return) or 110% of the prior year’s tax amount if adjusted gross income (AGI) was more than $150,000.

Conversely, service members can also request to have additional taxes withheld from their pay to cover taxes owed on taxable income such as interest and dividends, capital gains and self-employment. Another reason to have extra taxes withheld is the “marriage tax” where married couples with two employed spouses pay more tax together than they would if each spouse filed as a single taxpayer. This is especially true if each spouse has a similar income such as two spouses earning $35,000 for a total combined gross income of $70,000.

A helpful resource is the IRS Withholding Calculator ( Results from the calculator can help taxpayers complete their W-4 form to avoid having too much or too little tax withheld from their pay.