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PERSONAL FINANCE / KATHY M. KRISTOF

Adjusting Tax Withholding Is Easy--and Smart

October 09, 1994|KATHY M. KRISTOF

If you got married, divorced, had a child, sold something at a big profit, lost a job or bought a home during 1994, you need to think about federal taxes. That's because you may have told friends and relatives about the "big event," but you probably didn't inform your payroll department.

It's likely that your employer is withholding too much or too little federal tax from your paycheck as a result. And that's not smart.

If too much tax is withheld from your check, you effectively give a no-interest loan to the federal government. The government won't return the favor. If your employer doesn't withhold enough, you're likely to face a nasty surprise--in the form of taxes and possible penalties--in April.

Getting the withholding correct is your responsibility. And now is a good time to do it because, with three months remaining in the year, you still have enough time to make up a shortfall--or collect an overpayment.

The good news is that adjusting your withholding is fairly easy. You simply need to request a W-4 form from your employer and fill it out. (Your employer should have a ready supply. If not, you can get forms directly from the Internal Revenue Service by calling (800) TAX-FORM.)

The one-page form provides instructions. However, if you had a major event like the ones described above, the instructions may not be enough. That's because these events trigger tax issues that are not clearly explained in the form. What are these issues and how do you handle them on the W-4?

* Marriage: Adjusting your withholding will be a little tricky because the form doesn't account for the fact that you get the marital rate for the entire year--even if you got married in September. If just one of you is working, or if one of you makes a lot more money than the other, the marital rate will work to your advantage. But if not, you are likely to end up paying more tax than you would have paid alone.

If you want to get your withholding just right, you should estimate your 1994 liability by taking a look at both of your 1993 tax returns. Add together your combined wages and deductions and then look up the liability based on the tax tables' marital rate. Everything is adjusted for inflation so the calculation will not be exact, but it should get you close.

Compare the 1993 tax to the amount of tax already withheld from your respective paychecks--and a rough estimate of what will be withheld during the coming three months. If you haven't withheld enough, you can divide the underpaid amount by the number of pay periods remaining in 1994 and put the result on Line 6 of the W-4. If you withheld too much, you may want to add a few extra personal allowances on Line 5.

But, in either case, be sure to adjust your withholding again in January so the proper amount is automatically withheld in 1995.

* Divorce. You may assume you can still claim your children as dependents because you're providing child support payments, but that may not be true. Check your settlement. If your withholding level is based on having several dependents you can no longer claim, you may have seriously underpaid your tax.

* Births: If you have a new family member, you add a personal allowance on the W-4 work sheet. But, as with marriage, the amount withheld now cannot fully compensate for the fact that you get the deduction for the full year. Chances are, you've had too much tax withheld.

* Job loss: If you got unemployment insurance payments for more than a few months during 1994, it's likely that you have underpaid your tax. That's because unemployment payments are taxable, but tax generally isn't withheld from the checks. On the other hand, you might have overpaid if you were working most of the year and a lot of taxes were withheld.

* Capital gains. If you made a big profit on real estate or stocks, you may also have underpaid your tax. There are often ways to mitigate--or delay recognition--of these gains. For help, you'd be wise to consult a professional tax adviser.

* New home. First-time home buyers are likely to reap a tax bonanza. That's because mortgage interest expenses, "points" and property taxes all are tax deductible. If you bought a home worth $100,000 or more, those expenses could land you a tidy tax refund. But if you don't want to wait until next year to get it, fill out the work sheet on the flip-side of the W-4. The result should cause your employer to withhold less tax, boosting your take-home pay.

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