You could 'owe huge taxes' next year if you don't make this update, says CFP—how to check if you need to

We may be in the middle of the 2023 tax season, but it's not too early to check if you're setting aside enough for next season's filing.

That's because tax withholdings are estimates, which can end up being too much or too little money depending on your income and tax status, which may have changed since you last filed.

If you contribute too little money, you might receive a sizable tax bill you weren't expecting when you file your taxes next year. If the amount of unpaid taxes is large enough, you might also be subject to an underpayment penalty. That's because the U.S. tax system is pay-as-you-go, which is why freelancers and self-employed workers are expected to make regular quarterly tax payments throughout the year.

Conversely, if you allow too much money to be withheld, you might be shorting yourself on much-needed cash each month for no real reason, essentially giving the Internal Revenue Service an interest-free loan.

Here's how you can check your tax withholdings and make adjustments, if needed.

Whether your tax withholding is tabulated by you or an employer through a W-4 form, anything that changes the size of your tax liability, or the amount of taxes you owe, could change the amount of money you owe the IRS.

Aside from changes to your income, this includes a change in your marital status, retirement contributions, tax credits, health-care debt or whether you add a dependent.

"If your marital status has changed, your earnings have changed, or you are contributing quite differently this year to a 401(k) — perhaps to a Roth 401(k) instead of the traditional 401(k) — you need to review your tax withholding rate," says Michelle Gessner, a certified financial planner based in Houston.

Just one of the changes described above could have a big impact on your taxes. Take adding dependents, for example: They can lower your tax bill by thousands of dollars if you claim credits like the child tax credit, the child and dependent care credit or the earned income tax credit.

Your tax situation could also change if you receive a bonus from your employer. 

"Tax withheld on bonuses and stock compensation is typically — though not always — withheld at a flat 22% for federal taxes," says Carla Adams, a certified financial planner in Michigan. "For those who are in the 22% marginal federal tax bracket, this is not a problem at all. However, those in a higher tax bracket could owe huge taxes."

Of course, if you realize you're overpaying your taxes, you don't have to make adjustments, especially if it's not a lot of money. You can just claim the difference as a refund next year. But be aware that you won't receive any interest on that amount.

To check if you're under- or overpaying your 2024 taxes, you first need to determine your current withholding rate.

To do that, look for "federal income tax withholding" or "fed tax" amounts in a recent pay stub, for both the last pay period and for the year to date. You can also contact your employer's human resources department to confirm those tax withholding amounts.

From there, you can input those amounts into the IRS' tax withholding estimator. For workers with employers that withhold their taxes, the tool provides a year-end estimate of the taxes you'll owe, and will tell you if you're currently overpaying or underpaying taxes for the 2024 tax year.

Based on these calculations, the IRS tool then provides an updated Form W-4 with the relevant tax adjustment amount already added, whether that's an increase or a decrease. You can download that form and submit it to your employer, who will make the adjustment on your behalf.

Note that employers typically only handle tax withholding for the income that they pay you. They aren't responsible for freelance or self-employed income, or windfalls like lottery winnings.

If you are self-employed, filing your tax return can be a bit more complicated. Tax software will provide estimates for your expected quarterly tax payments, or you can also use Form 1040-ES, which has a worksheet to help you calculate how much tax you'll owe. You can pay your estimated quarterly taxes on the IRS payments page.

Ultimately, your employer "is not responsible" for making the "appropriate withholding," says Chris Mankoff, a CFP in Texas. "A best practice is to calculate your expected tax liability throughout the year and adjust accordingly."

He recommends W-4 tax filers check their withholding at least once every three months, either through the IRS withholding tool or a tax professional. If you're self-employed, he recommends tax software or consulting with a tax professional.

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