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New tax initiatives; new withholding blues.

By now it is no real surprise that most working Americans are "earning" slightly more per paycheck than they were just a month or so earlier as a result of one off President Bush's new tax initiatives. One predominating factor has justified the release of modified tax withholding tables: under the old withholding system, millions of Americans were overwithheld and ended up giving the government, in effect, an interest free loan annually. These withholding changes, now permanent - or as permanent as any tax law can be - are designed to benefit low- and middle-income wage earners, defined as single taxpayers earning less than $53,200 or married taxpayers jointly earning less than $90,200. They will increase take home pay by an aggregate nationwide amount of $25 billion over the coming year. This Administrative effort to revitalize the stagnant economy by pumping in this "new money" is now the subject of heated debate and criticism by some of the nation's foremost financial and economic experts, and might well be a major concern for your clients.

What all taxpayers must understand is the increase in their take-home pay is not because of a reduction in any personal income tax rates. Instead, payroll tax withholding tables have merely been lowered to remove some of the traditional built-in "padding" which normally results in the large refunds taxpayers have grown accustom to receiving. In actuality, American workers are getting an advanced payment on their income tax refunds for the tax year 1992.

Since the new withholding tables will affect a large number of taxpayers this year - conservative IRS figures estimate 89 million - your clients may or may not be pleased with the results of the lowered tables next April. The basic changes you will need to understand are shown in Table 1.
Table 1
Basic Changes in New Withholding Tables
Single Taxpayer
 * Annual withholding decrease by $172;
 * $14.33 monthly; or
 * $7.16 biweekly;
 * No decrease in withholding
 when gross wages exceed $53,200
Married Taxpayer
 * Annual withholding decreases by $345;
 * $28.75 monthly; or
 * $14.38 biweekly;
 * No decrease in withholding
 when gross wages exceed $90,200

Let's review these changes in three practical examples.

Example 1. A single worker with no dependents earns $2,200 a month and has $800 of interest income to report. The worker does not itemize deductions and claims no withholding allowances on Form W-4. Currently, $297.29 is withheld from this worker's pay each month. Beginning in March, this withholding dropped to $282.92 a month. Even with a reduction in withholding of $144 between March and the end of the year, this taxpayer will still receive a refund of $588 upon filing.

Example 2. A married couple with two children files jointly. The husband works earning $500 a week and the wife works earning $200 a week. They do not itemize when they file and their only income is from their jobs. Their combined weekly withholding would be $61.15 and the couple would neither owe money nor get refund when they filed. With the reduced withholding in March, their withholding would drop to $54.52 and they would owe $288 when they filed. The couple can avoid this by asking his or her employer to withhold enough extra tax ($5.60) each week (or each have $2.80 additionally withheld) to maintain their current level of withholding.

Example 3. A married couple with one child files jointly. The wife works earning $1,000 a week and the husband works earning $1,250 a week. They do not itemize their deductions and have additional income of $1,000 of interest income to report. The husband is paid weekly and claims three withholding allowances on his Form W-4. The wife makes no withholding allowance claim. Under the past tables, their employer would withhold tax from their pay at the rate of $165 (wife) and $198 (husband). Their total annual income is $117,000. As a result of the couple's combined income, they reach a point on the tax withholding chart at which the tables are no longer modified. The current withholding tax changes should have no effect on their personal tax situation.

This new system of withholding will obviously reduce the amount of every low- and middle-income taxpayer's refund. A major problem to be confronted is, in fact, that the IRS has estimated only 88% of those getting refunds in the past years will continue to receive them. Moreover, many will find for the first time ever that they still owe part of their tax liability when they file their 1992 tax returns.

One bright point: According to IRS Notice 92-6, the IRS will waive penalties, but not the interest, for any underpayment of estimated taxes in 1992 to the extent that the underpayment is caused by the adjustments to the withholding tables. This may be little comfort to your clients as they scramble to find additional cash to meet their unexpected, and possibly substantial, income tax deficit. You may be faced with an irate former client. The IRS has stated that it intends to review 1991 returns and inform those taxpayers that may be exposed to underwithholding. Still, this may not be enough to counter IRS' worst case estimates of next season's accounts receivable inventory increasing ten-fold.

There is little doubt that careful tax planning is needed to overcome the effects of the new withholding tables. Revised tables can be found in the Internal Revenue Service's Publication 15, dated February 1992. Begin informing your clients today about the expected result of next year's tax liability in relation to their current withholdings and encourage them to correct any undesired effects.

A quick approximation of these effects can be derived by: 1. Subtracting the estimated decrease in withholding

from the 1991 tax owed amount to arrive at the

projected 1992 refund; or 2. Adding the estimated decrease in withholding from

1991 tax owed amount to arrive at the projected tax

to be owed for 1992.

Review these findings for possible modifications to their present W-4s. Any taxpayer may elect out of the modified withholdings by filing a new W-4 and using line 6 to specify the amount of additional withholding to be deducted from each paycheck, as shown in Table 1.

In conclusion, there is no substitute for effective communication between tax professionals and their clients to overcome obstacles in the every changing world of federal income tax law.

Gary L. Green, Jr., is a masters degree candidate in federal taxation at George Washington University in Washington, D.C. As the tax analyst for NSPA, he is a frequent contributor to the National Public Accountant.
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Title Annotation:Special Report
Author:Green, Gary L., Jr.
Publication:The National Public Accountant
Date:Apr 1, 1992
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