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Withholding
- Don't give the government an interest-free loan
every year. Most people are happy to receive a big
refund every May or June. But this means that you've
given the government the use of your money, interest
free, for an entire year. There's no reason to do
this. You should have less money withheld from your
paycheck. Get a new Form W-4 from your employer and
claim some additional exemptions. Claim an exemption
for yourself and each dependent, and claim another
exemption for each $2,450 you have in itemized
deductions, tax shelter losses, business exemptions,
and IRA contributions. Your employer has to tell the
IRS when you claim more than 14 exemptions, because a
number of taxpayers are improperly claiming exemption
from withholding by asserting too many exemptions on
their W-4s. Don't be intimidated into claiming fewer
exemptions. Just be sure that this year's withholding
equals the lesser of last year's tax bill or 90% of
what you probably will pay this year.
Many people try to tell you that you cannot claim
a high number of exemptions. You can, but your
employer must report that to the IRS. You might get a
telephone call from the IRS asking about your number of
exemptions. If you do, simply pull out your worksheet
and explain why so little tax should be withheld from
your paycheck. If it appears during the year that
there is underwithholding from your paycheck, you can
file another W-4 and have more withheld. Your employer
probably won't like it but will have to abide by the
new W-4 you file.
- Estimated tax payments going to be too low? Don't
increase them. The tax law says you have to pay your
tax bill in equal installments during the year. If you
earn more money than expected and your estimated tax
payments for the first half of the year are too low,
you'll have a penalty for underpaying taxes. A way to
avoid this penalty is to increase withholding taxes on
your salary as soon as you notice that the estimated
taxes won't be enough. The tax law presumes that
withholding payments are made evenly throughout the
year, even if they weren't. By raising withholding
payments long enough to bring your total required
prepayments up to the minimum level, you avoid the
penalty.
- Underpayment penalties still can be avoided if your
estimated payments don't equal your tax bill. There is
no penalty if your estimated payments plus wage
withholding are equal to at least 90% of this year's
tax liability. You also avoid the penalty if your
prepayments at least equal last year's tax bill. So if
you are in a period of increasing income, the best way
to avoid the estimated tax penalty is to divide last
year's tax bill by four and make that the amount of
this year's quarterly payments.
A simplified estimated tax schedule is available
for high income taxpayers beginning in 1994. A high
income individual is someone whose adjusted gross
income for the prior year exceeded $150,000 ($75,000
for married filing separately). Such individuals can
avoid the penalty for underpayment of estimated taxes
if their quarterly estimated tax payments equal at
least 110% of the prior year's tax. Other individuals
still can avoid the penalty by prepaying either 90% of
the current year's tax or 100% of last year's tax.
- If the underpayment situation is really desperate,
but you can come up with the cash within 60 days, a
pension plan rollover may save you. With the 20%
withholding tax on pension plan rollovers effective
January 1, 1993, this technique is brand new. What you
do is take enough money out of your plan to have the
20% withholding tax be sufficiently large to cover your
tax prepayment shortage. It counts towards your total
withholding for the year when you do your tax return.
And as long as you pay the pension plan withdrawal
(including the 20% that was withheld) into a new plan
within 60 days, there is no tax penalty. So what you
have is a loan of the withheld money to cover your
underpayment penalty. Obviously you may lose a bit of
interest on the pension plan with this transaction, but
that is going to be a whole lot less than the penalty
for underpaying your estimated tax. Just be sure you
get the full amount of the money back into a pension
plan within 60 days, or you are going to have a much
worse problem than the one you started with, because
you will then pay income tax on the entire withdrawal
and a 10% premature distribution penalty.
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