Managing withholding as your family gets older--We end up paying tax every April. Each year it’s been getting worse, and this year it was fairly substantial! Our 2 kids are getting older; our daughter is about to graduate from high school and our son from college. Are we doing something wrong?
As your children get older, your tax situation changes. Are you having enough tax withheld?
First, let’s talk about your daughter. If she is a senior, she probably has just turned 17, and is no longer eligible for the $1000 child tax credit, even though she is still your dependent. Eligibility for the credit is measured by your child’s age as of the last day of the year. So if your daughter turned 17 during 2010, you couldn’t claim the credit on the tax return you just filed. That $1000 child tax credit comes right off the bottom line and reduces (or increases) the tax you owe dollar-for-dollar.
How about your son in college? The child tax credit for him is long gone, but are you still claiming him as a dependent? Generally, you can claim your children as long as they are under 19 as of the end of the year. If your son is a full-time student for at least five months, you can still claim him, provided he is under 24. If your son is providing more than half his support (other than scholarships) you can no longer claim him. Disabled children may be claimed regardless of age and there are also special rules regarding dependent children who are married.
For 2011, each of your dependents is a $3700 deduction. If you are in the 28 percent tax bracket, that’s going to reduce your taxes by about $1030 for each dependent you claim. But, as the nest empties, the benefits also fly away and the tax bill does go up.
You may have other circumstances increasing your tax bill. For example, as you pay off your mortgage, the amount you pay in interest declines and your interest deduction is going to be lower.
If you haven’t done it already, it’s time to adjust how much you are having withheld from both of your paychecks. Withholding is adjusted by filing IRS Form W-4 with your employer. You can get the form online from the IRS or your employer will have copies. There are similar forms for state income tax withholding. Be sure to complete those as well.
Getting withholding right can be tricky, particularly if you have more than one paycheck. And changing circumstances can throw the most careful estimates out of whack.
IRS Form W-4 has a worksheet to help you estimate the correct amount to withhold. But if you have special circumstances, like two income earners or if you itemize deductions, it can be a bit intimidating. Alternatively, you can use the special withholding calculator on the IRS website at www.irs.gov. It will ask you detailed questions about your situation and then will advise you as to the correct amount to have withheld. The IRS calculator has a helpful feature that takes into account how much has already been withheld for the year. So, particularly if it’s late in the year, the calculator can help you catch up your withholding if you haven’t had enough withheld or your circumstances have changed. Finally, you might want to ask your tax preparer for help, if you have one.
With low inflation, there are differences of opinion as to how much you should have withheld. In a perfect world, at tax time, you should neither owe nor get a refund. Financial gurus generally suggest that you should owe a little at tax time, but not enough to be penalized. That way you maximize the time value of your money. Still others say that, especially in times of low interest rates, withholding is a good way to save. Many people find it easier to bank that refund check than to try to save a little each payday. You’ll have to decide what works for you.
