A little cash relief is as close as your W-4 form

Home buyers who need a little more take-home pay to afford their bills don't necessarily need a second job or to dip into their savings.
By: Lew Sichelman: Los Angeles Times
By increasing the number of allowances claimed on tax forms filled out at work, they can boost their paychecks considerably. Exactly how much depends on the amount of mortgage interest and property taxes paid. But the more allowances claimed, the less federal income tax will be withheld.

Many people claim allowances equal to the number of people in their household — four, for example, in the case of a married couple with two kids — on Form W-4, the Employee's Withholding Allowance Certificate.

And every April 15, they ante up and square the ledger with Uncle Sam.

Others claim no allowances whatsoever, even if they have several dependents, preferring instead to pay more than their fair share of income taxes in advance and using the Treasury as sort of forced savings account.

In either case, though, these people are using as their banker an institution that pays no interest. They are giving the government free use of their money — money they could use to pay bills or place in an interest-bearing savings account.

Savvy taxpayers try to match their withholding with their actual tax liability. To the best of their ability, they determine in advance what they'll owe when the final tab is figured and adjust their withholding accordingly.

That way, they maximize use of their earnings and meet their income-tax obligations at the same time.

Even the Internal Revenue Service advises taxpayers to strive to have their withholding match their actual tax liability.

"If not enough tax is withheld, you will owe tax at the end of the year and may have to pay interest and a penalty," the federal tax collector says. "If too much tax is withheld, you will lose the use of that money until you get a refund."

By law, you must pay at least 90% of your tax liability in advance via withholding or the government could fine you.

Allowances are not just for dependents. They're also for deductions, and deductions can be taken for any number of expenses, including mortgage interest and property taxes.

To increase your cash flow, you can reduce the amount of income tax withheld each pay period by claiming special withholding allowances for every deduction you intend to take when you file your federal return.

All taxpayers are entitled to the actual number of exemptions claimed on their returns. And a special withholding allowance of one additional exemption is allowed when the taxpayer is single and holds only one job, or is married, has one job and his or her spouse does not work.

Additional allowances are also permitted for "excess itemized deductions," as long as they don't exceed an amount equal to the sum of last year's deductions and the amount of "determinable additional deductions" for the coming year.

Determinable deductions are those attributable to an identifiable event during the year, such as interest on a new or increased mortgage and property taxes.

Of course, you'll have to itemize to take advantage of these write-offs. If you claim the standard deduction, they won't do you any good. And if your total deductions don't exceed the standard one, there's no reason to fill out a long-form return.

But if itemizing makes sense, use the work sheet on the reverse side of the W-4 to determine the correct number of allowances. Each allowance claimed frees $3,300 of annual wages from withholding.

IRS Publication 919 (available online at http://www.irs.gov ) also contains a number of more complicated work sheets to project your withholding.

There are other methods too.

Camarillo mortgage broker Scott Friedman suggests: Multiply your loan balance by the interest rate and add in property taxes.

So, if your balance at the beginning of the year is $300,000 and your loan rate is 6%, the amount of interest you'll pay over the 12-month period will be $18,000. If you're paying $5,000 in property taxes, your total deduction as a result of your housing expenses is $23,000.

Now divide that by $3,300, and you get 6.9, meaning you can claim seven additional allowances. However, because you pay a little less interest every month, it might be better to round down to six extra allowances.

"This is a simplified example, but it's close," Friedman says. "The IRS doesn't pay you interest on taxes you overpay, so it makes sense only to pay what is due."

Another more precise way to determine allowances is to check the amortization schedule for your mortgage (free online at http://www.ourbroker.com , click on "Amortization") and your current property tax bill. Add up the amounts you will pay in interest with each payment. Then add in the property tax for the year, divide the total by $3,300 and the result will equal the exact number of extra allowances you can claim because of these two deductible housing expenses.

Once a new W-4 is filled out, your employer must put it into effect no later than the start of the first payroll period ending 30 days after submission of the revised form. Although there is no limit on claimed allowances, you cannot claim more than you are entitled to. Penalties are severe if you do. And don't think you won't get caught. Employers are required to submit copies of all W-4s from workers claiming more than 10 withholding allowances.