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The TSC Tax Forum is back, rested and ready to tackle some tax-planning issues for 1998. Going forward, each week we'll either answer some of your individual questions or address an issue we feel deserves fuller treatment.
This week, we wrestle with the seemingly simple but actually tricky Form W-4. Next week, as promised, we'll return to your Roth IRA inquiries. So send any new ones along. And let us know if there are any other tax-planning issues that you want us to investigate. We're at taxforum@thestreet.com. Please include your full name.
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Now that tax season is over, everyone from your local paper to your spouse is nagging you to redo your
Form W-4
. Easier said than done. "It's one of the most misunderstood forms out there," says Ray Russolillo, director of personal financial services at Price Waterhouse.
Form W-4 tells your payroll department how much money to withhold from your paycheck every pay period. "Form W-4 is your friend," says Larry Foster, KPMG's director of personnel financial services. Sure, if you can figure out how to complete it.
Let's face it: The instructions on the form stink. You think you're doing the right thing, adding up those 1s, but then you still get burned with a big payment.
We talked to some pros about how to do better next year. They suggest that you set that W-4 aside for the moment and figure out how much you can expect to owe in taxes in 1998. Then go back and adjust your W-4. We'll walk you through it. The Projected 1998 Tax Return
Those of you who have accountants may have taken care of this already. But for the rest of you who relied on Turbo Tax this year, boot it up. We're going to prepare a projected 1998 tax return -- the 1040. We'll use 1997's rates. Believe it or not, they are gradually decreasing from year to year. "If nothing else, you're being conservative," says Bill Fleming, director of personal financial services at Coopers & Lybrand.
Now get out your most recent pay stub. Find the gross income -- before taxes. Multiply it by the number of pay periods in the calendar year. If you made $1,000 a pay period and you get paid twice a month, then your annual salary is $24,000. Don't forget about any potential commissions or earnings that are not subject to withholdings. Add them all up and include that number on Line 7 of your projected 1998 1040 as your total wages.
Now you need to do the same with your federal withholding amounts. Look at your pay stub, the line that says: "Fed." Figure out how much is withheld a pay period and annualize that amount over the whole year.
Continue on through the form and estimate, as best you can, everything from potential interest and dividends to your itemized deductions. If capital gains hit you hard this year, be sure to include an equivalent amount for next year. For a shortcut, take it all from your 1040 this year.
If you're plugging away by hand, the 1998 income tax rates are available in
Publication 505 - Tax Withholding and Estimated Tax
. The updated standard deductions and income phaseout amounts are also included.
Once the form has been calculated, you make the call. Do you still owe a lot? Then you likely want to increase your withholding. Does your projection show a big refund? Then you're giving the government an interest-free loan.
In either event, it's back to the W-4. The Dreaded W-4
If you think you need to have more income withheld, there's no need to fiddle with the 1s. Just divide the balance due by the remaining pay periods left in the year, says Foster. Then drop that number on Line 6 of your new W-4, "Additional amount, if any, you want withheld from each paycheck."
If you believe you've had too much withheld, you've got to add some 1s to Line 5 of the form. Fleming offers up a ballpark figure: $700 per exemption. So if your 1998 projected return shows a refund of $2,100, then add three (2100/700) more allowances to your withholding on Line 5.
A small warning: If you claim more than 10 allowances, your employer is required to inform the IRS. It's nothing bad. They'll want you to justify your reasoning behind having so many allowances. Just be prepared to explain why you need to take home more.
If you're still confused, you can try using
Publication 919 - Is My Withholding Correct for 1998?
. It includes a worksheet that you can use.
Why bother with all this? "Any way you look at it, the right place to be is at break-even. It's the most practical," notes Russolillo. Come April, you won't be scrambling to come up with your payment due. Nor will you be kicking yourself for loaning Uncle Sam too much free money.
Don't be afraid to revisit it every now and then. "If you have investments, you want to look at your tax situation every quarter," says Ron Roge, financial planner with R.W. Roge & Co. He suggests you reevaluate your withholdings every time you receive a cap gains distribution, just to make sure that you're going to be covered at year-end.
What About State Withholding?
Just when you thought you were done, there's another government to contend with. Whatever allowances you elect on your federal W-4 will carry over to your state (that does not include any specified dollar amount on Line 6). But if you found that your state withholding just wasn't enough -- and lots of people did this year -- then Russolillo recommends that you do the same projection for your state.
Calculate a 1998 state tax return, and figure out any additional withholdings you may need. You can then download your state's W-4 form (all states' forms are available at
www.1040.com
, but note that some states may not have a Form W-4) and submit it with the changes. Or even easier: Just let the folks in human resources -- or the equivalent -- know the additional dollar amount you want withheld for your state. The people who process your payroll checks will know what to do.
Hope this makes next April happier. There are enough surprises in life. You surely don't need one from Uncle Sam.
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