New W-4 Form: Weighing Long and Short of It
Aside from the usual shock over the difference between gross and net on one’s paycheck, it’s the rare person who thinks about his tax withholding from one year to the next. Most people are only vaguely aware that the more deductions and/or the more dependents they have, the less tax will be due, and the less tax due, the less they could have withheld from their paycheck.
Over the years, some people have changed their withholding when they had children, adding exemptions. More likely, they adjusted their exemptions only when they bought a house, and even then, maybe not: Sighs one California homeowner, “It just seemed like a lot of trouble.”
Indeed it is, as all taxpayers learned this year when the Internal Revenue Service issued a new and intimidating W-4 form and work sheet so people could recalculate their withholding. The ensuing furor forced the IRS to issue a simpler version. The American taxpayer just didn’t have “the willingness and capacity,” said IRS Commissioner Lawrence B. Gibbs, “to match withholding with tax liability.”
‘Pay-As-You-Go’
When withholding was introduced in 1943, it was simply one way the government had devised to get its tax monies sooner--a matter of some import if Congress was going to cover the high cost of World War II. This so-called “pay-as-you-go” plan took taxes out of each paycheck throughout the year: Government thus became the first creditor paid, instead of the last, as it was when tax time came but once a year. “Government doesn’t have to wait for its money,” says IRS spokesman Rob Giannangeli in Los Angeles, “and it doesn’t want to go after it a year later when chances are you don’t have it any more.”
Government got what it wanted, and more: 75% of taxpayers pay in more than necessary and are due refunds at year-end, probably because they list their actual number of dependents (i.e., exemptions) and then claim deductions in April that cut their taxes even further. Some are purposely conservative, treating income taxes as “a forced savings program,” in Giannangeli’s words. “I understand it in principle,” says Los Angeles business analyst Gail McClellan, “but even when you buy a house, you’re afraid to change the withholding because of the lump sum you might have to come up with in April.”
At the same time, a certain number of taxpayers declare many more dependents than they actually have--5, 10, even 15--knowing that they’ll have high deductions (mortgage interest, medical expenses, perhaps investment losses), which will keep their taxes low, and preferring bigger paychecks to once-a-year refunds. Some care is needed in playing this system, however: Under “pay-as-you-go,” there are substantial “underpayment penalties” (9% a year computed quarterly) for taxpayers who end up in April owing more than 20% of their total year’s tax.
Axed Deductions
The new tax law of 1986 threatened to put a good many taxpayers in jeopardy. For one thing, starting with 1987 taxes, it changes the 20% rule to 10%. For another, it did, as loudly advertised, lower the tax rates and thus the withholding rates and increase the value of each exemption to $1,900 from $1,000, so that less will be withheld. But it axed deductions right and left--IRA contributions, the two-earner couple deduction, sales tax, 35% of non-mortgage consumer interest--so that come April, more could be owed.
Given the ballyhoo over tax reform, it would hardly do for government to warn everybody that they might owe a lot more money in April and would be well advised to list fewer exemptions and have even more taken out of their paychecks. Instead, all taxpayers were asked to “re-evaluate” their withholding and “realign” it with their expected tax liability (IRS talk for trouble ahead).
Enter the new W-4, with the accompanying work sheet that caused such a flap. Actually, it just asked people who didn’t expect to itemize to add up their dependents and the number of jobs in the family worth more than $2,500 a year, and it asked itemizers to add up both their dependents and their expected deductions, and by simple division, figure out how many $1,900 exemptions those deductions were equivalent to.
Unfortunately, it presented an 8-by-11-inch sheet of tax tables, and three pages of instructions and interlinear commands with the characteristic IRS lilt: “If line K is zero, skip to Line N,” and “if you think you might be exempt from withholding, read the instructions for Step 2 below. Otherwise, skip to Step 3 on page 2. If you want to have more money withheld from your pay, see Step 4 on page 2,” and, by the way, “criminal penalties apply for . . . failing to supply information requiring an increase in withholding.”
It also asked that each person planning to itemize prepare an abstract of next year’s 1040, estimating adjustments to income, itemized deductions, tax credits. In essence, the taxpayer had to work out his future taxes in some detail--an exercise that struck many as onerous, unnecessary and of no great personal advantage.
Under pressure from Congress, the IRS acknowledged that less accuracy would be adequate and produced a new “new” W-4 specially for the unwilling and incapable.
It was shorter, slightly clearer, left out some steps, provided tiny and compressed tables and permitted rounder estimates.
Taxpayers thus have some choice. Those who used to calculate how little withholding they could get away with, given their expectations of ultimate adjustments and deductions, can continue to do so, with the benefit of a work sheet to guide their calculations.
The only codicil is that if they claim more than 10 exemptions, the IRS will check that it’s financially justified.
Those who find it too much trouble can use the short form. Given its omissions, this will probably leave them, says Giannangeli, “a little bit overwithheld.” But then, they’re probably the people who always were, and that’s the way the IRS wants them.
