Adjust Your Withholding

Don't Give Uncle Sam an Interest-Free Loan

By Dr. John L. Stancil
Tax Analyst, WebTaxCenter.com

Seventy-seven percent of Americans loan money and don't charge interest. Sound incredible? Something you would not do? Think again. Last year 77% of Americans filing a tax return received a refund. The average amount of these refunds was $2,141. When you have too much federal income tax withheld from your pay check, you are giving Uncle Sam a tax-free loan.

To make the situation even worse, many pay large fees to get their own money back even quicker. I am talking here about refund anticipation loans. These loans are expensive, with fees ranging from $30 to well over $100. This amounts to an annual rate of 60% to over 700%. Just to get your own money back a week or two earlier. If you have a refund coming, you will get it within 15 days or less if you file your return electronically and have the refund direct deposited to your account.

Pay Yourself

But people say they like the "forced savings," they like the big bonus that come with a large refund. Instead of having too much taken out of your check and not receiving any return on those excess withholdings, then paying to get your own money back why not force yourself to save? The average refund of $2,141 is about $175 a month. It is a simple matter to have $175 (or some other amount) withdrawn automatically from your bank account each month and invested in a stock mutual fund or in a money market fund. You earn on your investment and it is available when you need it.

Avoid a Penalty

But you say you don't want to owe and you don't want to pay a penalty. No problem. If you owe, you have the money that you have been putting aside each month. You can take steps to assure that you do not owe a penalty. There are three exceptions and if you meet just one of them, you will not have to pay a penalty if you owe.

1. If the amount you owe is less than $1,000.
2. If the amount you paid in is equal to at least 90% of your tax liability for the current year.
3. If you paid in an amount equal to your tax liability for the previous year.

Give Your Employer the W-4 Treatment

To adjust your withholding, just complete a new W-4 and give it to your employer. There is a worksheet attached to the W-4. Remember that you should not claim more withholding allowances that you are allowed. If you are married, you and your spouse should do this together and divide the number of allowances between the two of you.

If you find the worksheet too confusing and you have been getting a refund, just increase your withholding by one or two allowances. The number of allowances you take and the refund or additional payment you need to make when you file is in part a trial and error system. So just experiment until you get it right.

Don't Get Carried Away

It has become popular in some circles to claim as many as 99 withholding allowances for a short period of time to "give yourself a little raise." This is not a good practice. First, you might get used to the extra money and not change it back to the old level of withholding.

Another popular way to avoid withholding is to claim to be exempt from withholding. You can claim exemption from withholding only if you had no tax liability in the prior year and you expect to have no tax liability in the current year. Again, this is not a good idea unless you really are qualified to be exempt. When an employee claims more than 10 allowances or claims to be exempt, the employer is supposed to send a copy of that W-4 to the IRS.

Falsely claiming exempt or claiming a number of allowances that you have no reasonable basis for can result in fines of up to $500. When you submit a W-4 to your employer you sign it, certifying "Under penalties of perjury, I declare that I have examined this certificate and to the best of my knowledge and belief, it is true, correct, and complete."

More information about this subject can be found in the instructions to Form W-4, from your tax professional, or at www.webtaxcenter.com.

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Dr. John L. Stancil, a tax analyst for WebTaxCenter.com, has been a member of the Florida Southern College faculty since 1998. He received his bachelors degree from Mars Hill College and holds a M.B.A. from the University of Georgia. He later earned his doctorate in accounting from the University of Memphis. He holds four professional certifications, including CPA, CMA, CFM and CIA. Stancil has received the Florida Institute of CPAs 2005 Outstanding CPA in Public Service Award. (This award is given annually to a Florida CPA who has demonstrated significant contributions through community and civic activities.) He has also been recognized as the Expert of the Month on several occasions by allexperts.com.

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