by Andrew D. Schwartz, CPA
Boy is the tax code complicated. Does the complex set of rules cause you to be surprised by the amount of money you end up paying or getting back on your taxes each year?
The biggest culprit is the reconciliation process known as the Form 1040. Each winter, you tally up all of your various sources of income from the prior year, then claim your allowable deductions against that income to determine your taxable income. Based on that figure, you calculate your regular tax liability and your alternative minimum tax liability, and pay whichever one is higher.
Here’s where many CPA offices take on the feel of a high-stakes casino. If the amount of taxes paid in during the year through withholdings and estimates exceed your tax liability, you feel like a winner. When your total tax bill dwarfs the payments you made during the year; sorry, dealer has twenty-one.
In this series, we?ll visit some of the common causes of an April 15th surprise:
Cause #1: Misleading Withholding Tables
Let’s start by admitting that the withholding tables do not work so well. It’s not uncommon for highly compensated taxpayers to have only W-2 income and either owe the IRS five figures or get a substantial refund.
The W-4 form appears to be easy enough to complete. Simply check whether you’re single or married, and jot down the number of “allowances” you want to claim. Presumably, you claim an allowance for you, your spouse, each of your kids, your mortgage, and any other sizeable deduction you can claim. The problem is that with each additional allowance, less taxes are withheld, even though your tax liability might not change by all that much due to the Alternative Minimum Tax or a variety of other factors.
A second problem is that each employer withholds taxes as if they are your only employer. Work for multiple employers during the year, and there is a good chance that you’ll find yourself under-withheld. (However, if your total earnings exceed $110,100 during 2012 and you work for more than one employer, you’ll end up with excess FICA taxes withheld which counts as additional federal taxes paid in.)
If you’re married, watch out, since the withholding tables assume your spouse doesn’t work. For that reason, a married couple comprised of two working spouses may find themselves to be under-withheld by 6% or more on their total wages. On $300k of combined income, that translates into a shortfall of $18,000! I surprised more than a few well-compensated couples with the news that they owe more than $10k in taxes, even though their only income was W-2 wages, and they were confident that they completed their W-4 forms correctly.
The IRS is well aware that the W-4 form can be quite misleading. For help completing the W-4 form correctly, check out theIRS’ Online Withholding Calculator.
Coming up: Cause#2 – Not All Breaks Are Equal