5/11 W2 Issues

I will try to make this as simple as possible. It is a very confusing area of tax law. When I look at hundreds of tax returns in a tax season, I get a feel for what the past year's tax code changes do to the refund/balance due. I also read the next year's tax laws so I have a good understanding of what to expect next tax season.

Many taxpayers found that they received less back than they did in prior years. That is because the federal government is manipulating the amount you take home in your paycheck. They have given you more each pay period so you will hopefully spend that money and supposedly stimulate the sluggish economy.

Tax brackets are also manipulated each year by the federal government.

When the tax return is completed and you expected a higher refund, you find out that the amount you had withheld is lower than before. That is exactly the issue. I have seen some W2s with almost nothing withheld.

You need to match your tax bracket with your income in order to get the correct amount withheld each pay period. By using the W4 form that your employer gives you to fill out each year to determine at what level you should be withholding, you will, 90% of the time, get the wrong answer.

You need to know what your percentage tax bracket is and have that rate used by your employer.

If you file a 1040 (not the 1040EZ or 1040A forms), look at page 1, line 7, that is your gross W2 wages. Now look at page two, line 43, that is your taxable income. Look at line 44 and that is your tax debt and now look at line 61 which is your withholding. Line 73 is your refund.

By dividing line 44 (federal taxes) by line 7 (gross wages) you get the percentage of withholding you have chosen. If line 73 is a refund you like, then you are okay. It should be more than $400.00 if single and more than $800.00 if married. Why? Because the Making Work Pay credit from line 63 is going away in 2011.

Thus, if you show a refund of $400.00 or less on line 73 and you are single, you will owe next year. If you are married and your refund is $800.00 or less in 2010, then you will owe next year. I have seen many situations exactly like this recently.

This issue is especially true when you have more than one W2 income source for the year. The withholding tables presume you only have one W2 and when you have more, they treat each one the same way and thus the total withholding is wrong.

Income from social security, pensions, interest, dividends, capital gains and self-employment make this formula even worse. I am not going to go there in this letter. The concept is the same though. When you make estimated taxes or have money withheld from the source, you need to be sure you have the right amount withheld.

The IRS and States penalize you if you underpay the taxes during the year.

Most of my clients are beyond this issue because I normally catch the problem while doing the tax return and notify them about changing the withholding status to where it should be.

Your tax bracket is line 44 (tax) divided by line 43 (Taxable income). This does not take into account the credits available on lines 47 through 53, self-employment and other additional taxes, plus other credits on lines 64 through 71. That makes this more complicated but, again, the concept is what I am attempting to get across, not specifics.

In many situations, the amount on line 60 (total tax) is your actual tax, after some credits. Then this number is divided by your line 43 (taxable income) to determine your tax bracket but I have seen the credits from lines 47 through 53 change each year so it makes it hard to determine the next year's tax bracket based upon that formula alone. Sorry for the confusion.

Any good tax person can read this letter and make sense of what I am trying to say.

Yesterday, a client came in, who has a new seasonal job and told me he is now at single, three dependents based upon the W4 form. He is actually single with no dependents as per his tax return. That is so frustrating. He will have to have an additional $64.00 per paycheck withheld to just break even at year's end. If he did not tell me, he would owe about $800.00 at year end.

On top of all this, the feds are taking 2% less from your social security withholding this year. This puts 2% of your wages back into your hands. The trade off is the Making Work Pay credit is gone this year.

Think about that please. They give you 2% of your income back to you in your paycheck but increase your tax debt by $400.00 per single person and $800.00 per married couple at year end. The two issues do not match at all. If they were adjusting your federal withholding instead of the social security, then they would, possibly, match but now they will not. Actually, it would only match if you make exactly $20,000.00 per year.

That is exactly why you must take a careful look at your wages versus your withholding this year because you do not want to be owing the government money next winter.

The federal and state tax agencies charge hefty fines if you owe over a certain amount at year end.

side note: If you have a number of children under age 17 and do not make a lot of money, you likely are getting thousands of dollars back even if you paid little or no withholding taxes during the year. This is due in part to the Earned Income Credit, "Additional" child tax credit, and other "refundable" credits. These are some of the ways Congress has manipulated the tax code to become a safety net for the less fortunate members of our society.

If you are okay with your tax situation, that is great, otherwise, make an effort to correct it soon. Please give this letter to someone else, especially your employer or co-workers plus family and friends who need to know about this problem.


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Comment by Patriot Eagle on July 18, 2011 at 8:49pm
linda, excellent question. the first thing to ask is whether or not the disability will be federally and or state taxable.  if taxable, then you add the taxable amount to your husband's income and that will give you gross income.  from that you subtract itemized deductions and allowable exemptions.  this gives you taxable income.  look this up in the tax tables and you get your taxes.  divide this figure by your gross income and you get your tax bracket.  This is the percentage of income you want withheld from your disability  It is due when you get the money and not at year end.  you can contact me at my alternative email addy at patrioteagle912@yahoo.com.  from there we can get specific and I will walk you through the calculations.
Comment by linda13 on July 7, 2011 at 4:02am
patrioteagle1, i have a question about how much to withhold for taxes.  i couldn't find where to send you a private message so i've kept this somewhat general.  what's happening is i've been on short term disability from my employer (no federal, state, local taken out) and in a couple of months i'll be going on long term disability (no taxes of any kind taken out).  i don't know how much, or what percentage i should put back so my husband and i don't get smacked in the pocket come tax time.  should my husband increase what they're taking out of his paychecks or should we set money aside in the bank or???  any suggestions are greatly appreciated!

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