Adjust withholding on W-4 to keep tax credit on track

Your next paycheck will probably be a little fatter than usual, but it's not because your boss thinks you're swell. Instead, the increase reflects the Making Work Pay credit, part of the economic stimulus package enacted this year.

Most taxpayers will receive a credit of about $400, or $800 for married couples. Unlike last year, you won't receive a check in the mail. Instead, the credit will be spread out over the year. Most taxpayers will receive an extra $10 a week.

That's not exactly a windfall, but a little something extra in your paycheck sure can't hurt, right? Well, actually, it could. Some taxpayers could end up with a smaller-than-average tax refund next year or — horrors — discover they owe the IRS money. You can avoid problems down the road by adjusting the withholding allowances on your W-4. Consider reviewing the number of allowances you claim if:

•You're a dual-income couple. The IRS withholding tables are designed to provide a maximum tax credit of about $400 for single taxpayers, and about $600 if you are married and file jointly, says Bob Trinz, senior tax analyst for Thomson Reuters. That could cause some working couples to receive a larger combined credit than allowed by law.

For example, suppose you earn $75,000 a year, as does your spouse. Both of you claim two withholding allowances. You'll each get a $614 credit, for a combined credit of $1,228, according to Thomson Reuters. However, the maximum credit a married couple is eligible to claim is $800. Unless one or both of you increase the amount of taxes withheld from your paychecks, you could end up owing the IRS money when you file your taxes next year, Trinz says.

Conversely, Trinz says, if only one spouse works, the couple could end up with a smaller credit than they're entitled to. Here's an example, from Thomson Reuters: A married man earns $100,000 a year and claims four withholding allowances. His wife is a homemaker. He'll receive a credit of $614, even though the couple are entitled to an $800 credit. This couple can claim the balance of the credit when they file their taxes, or they can get the money sooner by reducing their withholding.

•You have more than one job. If you're working two jobs, both of your employers will adjust your take-home pay to reflect the new credit. The combined credit from both jobs could exceed the maximum $400 credit for individual taxpayers, says Michael O'Toole, director of government relations for the American Payroll Association.

•Your total income exceeds the thresholds for the credit. The Making Work Pay Credit phases out for single taxpayers with modified adjusted gross incomes of more than $75,000, and married couples with modified AGI of more than $150,000. Singles with modified AGI of more than $95,000 and couples with MAGI of more than $190,000 are ineligible for the credit.

Your employer will base the withholding calculation on the amount of income from your job. But if you have other sources of income — from a second job, for example — your total income could "bump you out of the range to be eligible for the full credit," says Amy McAnarney, director of H&R Block's Tax Institute.

Likewise, some dual-income couples could run into problems if one spouse receives the credit but the couple's combined income exceeds the income cutoff.

Reviewing your W-4

Even if you have no tax-credit worries, take a look at your W-4 anyway. Tax preparers recommend reviewing the number of allowances you claim on your W-4 whenever you have a major life change, such as the birth of a child, marriage or a home purchase. But a recent survey by H&R Block found that 44% of workers haven't adjusted their W-4s in at least three years.

If you had to write a big check to the IRS this year, that's a sign that you're not having enough withheld and need to reduce the number of allowances on your W-4. Likewise, taxpayers who receive a large refund should consider increasing the number of allowances they claim.

Many taxpayers resist this idea because they like receiving a check from the IRS. But in these economically challenging times, giving the government an interest-free loan makes no sense, says David Bergstein, a tax analyst for CCH CompleteTax, an online tax software program. When you file your taxes, he says, "You should break even."

There are several Internet calculators to figure out how many allowances you should claim. CCH offers one at completetax.com/calc.asp.

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. Click here for an index of Your Money columns. E-mail her at: sblock@usatoday.com.

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comment:

Letting the government have use of your hard earned money, interest free, for a whole year is STUPID. Through adjusting my own W4 and having a few dollars each pay additional withholding taken out - I and the government break even at tax time. It's great as far as I'm concerned.

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Don't Let Rush to File Taxes by Deadline Lead to Errors

Gentlemen (and ladies), start your engines. Tax Day is less than a week away.

But as you race toward the finish line, be mindful of common tax-filing errors. Some mistakes could cost you money. Others could raise red flags at the IRS. Tax software will do math and point out tax breaks you might overlook, but these programs are only as good as the information you enter.

Here are some common last-minute blunders, and how to avoid them:

Automatically not itemizing.

A 2002 study by the Government Accountability Office found that more than 2 million taxpayers who claimed the standard deduction could have lowered their tax bills by itemizing.

Deductible expenses include interest on your mortgage, property taxes, charitable contributions and unreimbursed medical expenses that exceed 7.5% of your adjustable gross income.

Ordinarily, that threshold puts the medical-expense deduction out of reach for most taxpayers who have employer-provided health care.

But the economic downturn has led employers to shift more of the cost of health care to their workers in the form of higher deductibles, co-payments and co-insurance. That means more taxpayers could rack up enough unreimbursed expenses to claim the deduction, says Mary Canning, dean of the schools of taxation and accounting at Golden Gate University in San Francisco.

Automatically itemizing.

Some homeowners assume that they should always itemize because the interest on their mortgage is deductible, says David Bergstein, tax analyst for CCH CompleteTax, an online tax software program. But if you've paid off most of your home loan, your mortgage-interest deduction may be so small that you're better off taking the standard deduction.

For 2008, the standard deduction is $5,450 for single taxpayers and $10,900 for married couples who file jointly. If you're 65 or older or visually impaired, you're entitled to $6,800, or $13,000 for a married couple (assuming that both spouses qualify).

The general rule is that if your deductions exceed those amounts, you should itemize.

But this year, there's a new twist. The foreclosure rescue bill enacted last summer allows homeowners who don't itemize to increase their standard deduction by the amount of their property taxes. The maximum property tax deduction is $500 for single homeowners and $1,000 for married couples.

This could make the standard deduction a better deal for folks who usually itemize. If you've gotten out of the habit of saving your property tax bills — perhaps because your home is paid off and you no longer itemize — dig out those records so you can take advantage of this tax break, Bergstein says.

That's not the only way taxpayers will be able to increase their standard deduction this year. If you suffered casualty losses last year in a presidentially declared disaster area, you can increase your standard deduction by the amount of your unreimbursed losses.

To determine whether you live in a federally declared disaster area, go to www.fema.gov.

Claiming a deduction instead of a credit.

A recent survey by tax publisher CCH found that less than a quarter of taxpayers realize that tax credits are actually more valuable than tax deductions.

Tax credits provide a dollar-for-dollar reduction in your tax bill. Deductions only reduce your taxable income. For example, if you're in the 25% tax bracket, a $2,000 tax credit will reduce your tax bill by $2,000. A $2,000 tax deduction will lower your tax bill by $500.

Confusing deductions and credits could cost you, particularly when it comes to tax breaks for college.

In the CCH survey, 41% of taxpayers said that the $4,000 tuition and fees deduction was more valuable than the Hope or Lifetime Learning credits.

In fact, though, a parent in the 15% bracket who claims the full tuition and fees deduction would save $600, vs. up to $2,000 from the Lifetime Learning credit.

Incorrectly deducting property taxes.

Taxpayers who itemize can deduct real estate taxes, but only in the year they were paid. Often, though, taxpayers pay property taxes in installments that cross calendar years, Canning says, which can lead to filing errors. For example, if you paid the first installment on 2008 property taxes in December 2007 and your second installment in 2008, only the second installment is deductible on your 2008 tax return. However, the first installment toward 2009 taxes would be deductible on your 2008 tax return, if you paid it in 2008. Advance or late payments can further complicate matters, Canning says.

Fortunately, many counties now post property tax records on their websites, Canning says. You can use these websites to find a record of how much you paid in property taxes and, more important, when you paid them, she says.

Not reporting self-employment income.

The sharp rise in unemployment has forced many out-of-work taxpayers to go into business for themselves. If you did freelance or consulting work last year, make sure you report all your income on Schedule C when you file your tax return, Canning says. Don't rely on 1099s from clients or customers because not all payers are required to send you that form, she says. Review deposits in your bank or checking accounts for income that wasn't reported on a 1099, Canning says. If you're audited, she adds, "That's what the IRS will do."

At the same time, don't overlook deductions that will reduce taxes on your self-employment income. Potential deductions include everything from the cost of office supplies to transportation expenses when you visit clients. If you work in a dedicated space in your home, you may also qualify for a home-office deduction.

Some self-employed taxpayers worry that claiming the home-office deduction will increase the chance they'll be audited by the IRS. But if your deductions are legitimate, you shouldn't fear the feds, Bergstein says.

"Tax avoidance is perfectly legal, he says. "Tax evasion is not."

By Sandra Block, USA TODAY

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READ MORE - Don't Let Rush to File Taxes by Deadline Lead to Errors