Were You Surprised on April 15th?


Wow, is the tax code complicated. Does the complex set of rules cause you to be surprised by the amount of money you end up paying or getting back on your taxes each year?

Wow, is the tax code complicated. Does the complex set of rules cause you to be surprised by the amount of money you end up paying or getting back on your taxes each year?

The biggest culprit is the reconciliation process known as the Form 1040. Each winter, you tally up all of your various sources of income from the prior year, then claim your allowable deductions against that income to determine your taxable income. Based on that figure, you calculate your regular tax liability and your alternative minimum tax liability, and pay whichever one is higher.

Here's where many CPA offices take on the feel of a high-stakes casino. If the amount of taxes paid in during the year through withholdings and estimates exceed your tax liability, you feel like a winner. When your total tax bill dwarfs the payments you made during the year; sorry, dealer has twenty-one.

Here are some of the common causes of an April 15th surprise:

> Misleading Withholding Tables:

Let's start by admitting that the withholding tables do not work so well. It's not uncommon for highly compensated taxpayers like physicians to have only W-2 income and either owe the IRS five figures or get a substantial refund.

The W-4 form appears to be easy enough to complete. Simply check whether you're single or married, and jot down the number of “allowances” you want to claim. Presumably, you claim an allowance for you, your spouse, each of your kids, your mortgage, and any other sizeable deduction you can claim. The problem is that with each additional allowance, less taxes are withheld, even though your tax liability might not change by all that much due to the Alternative Minimum Tax or a variety of other factors.

A second problem is that each employer withholds taxes as if they are your only employer. Work for multiple employers during the year, and there is a good chance that you'll find yourself underwithheld. (However, if your total earnings exceed $102,000 during 2008 and you work for more than one employer, you'll end up with excess FICA taxes withheld which counts as additional federal taxes paid in.)

If you're married, watch out, since the withholding tables assume your spouse doesn't work. For that reason, a married couple comprised of two working spouses may find themselves to be underwithheld by 6% or more on their total wages. On $300,000 of combined income, that translates into a shortfall of $18,000! I surprised more than a few well compensated couples with the news that they owe more than $10,000 in taxes, even though their only income was W-2 wages, and they were confident that they completed their W-4 forms correctly.

The IRS is well aware that the W-4 form can be quite misleading. For help completing the W-4 form correctly, check out the IRS' Online Withholding Calculator.

> Not All Breaks Are Equal:

Not all tax breaks are created equal. Certain changes to your financial or personal situation generally guarantee a big April 15th surprise. Get married or buy a home during the year, and chances are good that you have no idea how your taxes will end up that year.

Other tax breaks that seem to indicate a substantial savings don't end up impacting your tax situation much at all. Believe it or not, having a baby or sending a child to college saves you very little in taxes unless your income is relatively modest.

What if you take full advantage of a retirement savings plan offered by your employer? While money contributed into the plan through salary deferrals saves you taxes, your employer reduces the taxes withheld from your pay by an equivalent amount since the withholding tables are based on your taxable earnings instead of your gross earnings. So even though maxing out your salary deferrals is one of the best tax shelters available to you during your working years, you will generally not see much of a change to your refund or balance due by doing so.

> Delayed Reaction:

Another contributing factor to a big tax surprise is the fact that even though you make the bulk of your tax planning decisions during the year, you don't see the impact of those decisions until you prepare your returns the following winter. When you finally work through your paperwork and realize there is an issue to address, the next year is already one-quarter done, leaving you just nine months to make any necessary adjustments. And then, if you forget to make a second set of adjustments the following January, you'll find yourself with another April 15th surprise when you prepare your taxes for that year.

Besides setting the rates for your withholdings and estimates, another common example is paying for a child's dependent care expenses with pre-tax dollars through your employer's flexible spending account. While this strategy generally makes a lot of sense, it backfires if your spouse has no earned income during the year.

Lets say you paid for $5,000 of childcare expenses with pre-tax dollars through your employer's FSA, but your spouse didn't earn any income during the year. When you prepare your taxes, you'll need to add that $5,000 back to your taxable wages, increasing your federal tax bill by up to 1,750, with no accompanying withholding. And then, since you most likely sign up for your benefits annually during November, once you realize this pitfall, it's too late to undo the election for the current tax year.

> Good Intentions + Complex Rules = April 15th Surprise:

Which of these goals did you set last month?

• Minimize your tax burden

• Adjust your withholdings

• Maximize your contributions to tax-advantaged savings opportunities

With the April 15th deadline still a not-too-distant memory, invest some time now to make those adjustments necessary to avoid a big tax surprise next April.

Andrew D. Schwartz, CPA is the founder of The MDTAXES Network, a national network of CPAs who specialize in providing tax services to healthcare professionals. A frequently-quoted tax advisor, his firm of has over 45 years of combined experience specializing in the tax issues affecting health care professionals. For more information call 800-471-0045 or e-mail, cpa@mdtaxes.com.

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