EASING THE MORTGAGE PAYMENT PINCH
What Congress giveth, Congress taketh away. And so it was that on Jan. 1, most wage earners found themselves a little light in the paycheck.
The reason, of course, is that lawmakers late last year allowed the 2 percent cut in the employee portion of the FICA tax to expire. That benefit was enacted in 2010 to put more cash in taxpayers' wallets during the tough economic downturn.
But the greater tax burden doesn't mean would-be homebuyers need to put off taking advantage of some of the lowest mortgage rates in eons. You can raise your take-home pay to where it was -- or perhaps bring home even more money -- by simply increasing the number of allowances on the tax form you fill out at work.�Exactly how much more take-home pay depends on how much interest you pay on your mortgage and how much you pay in property taxes. But the more allowances you claim, the less federal income tax your employer will withhold.
Many people report only their dependents -- four, for example, in the case of a married couple with two children -- on Form W-4, the Employee's Withholding Allowance Certificate. And every April 15, these taxpayers have to settle up with Uncle Sam. Others claim no dependents whatsoever, even if they have several, preferring instead to pay more than their fair share of income taxes in advance and use the Treasury as a sort of forced savings account.
In either case, though, these people are using as their banker an institution that pays absolutely no interest. They are giving the government free use of their money -- money they could use to pay their bills, including their mortgage, 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 how much they'll owe when the final tab is figured, and they 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 check to make sure their withholding matches 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."
Form W-4 asks taxpayers to list their allowances so their employers can withhold the proper amount from their pay. But allowances are not only dependents. They also include deductions that 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. A special withholding allowance of one additional exemption is allowed when the taxpayer is single and holds only one job, or is married and has one job and a spouse who does not work.
Additional allowances also are permitted for "excess itemized deductions," as long as they don't exceed the sum of last year's deductions and the amount of "determinable additional deductions" for the coming year. Determinable deductions are those that are attributable to an identifiable event during the year, such as a binding obligation to make payments. In other words, 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 take the trouble to fill out a long-form return.
But if itemizing makes sense, use the worksheet on the reverse side of the W-4 to determine the correct number of allowances. Currently, each allowance claimed frees $3,900 of annual wages from withholding.
Say, for example, that you purchased your first home on June 30 last year. On your 2012 tax return, you claimed itemized deductions of $6,600, which was the sum of the mortgage interest and property taxes you paid during the first six months of ownership.
Based on those amounts, you can expect to claim roughly $13,200 for those two deductions on your 2013 return. So, if you divide $13,200 by $3,900, you come up with three more allowances that you can use to increase your cash flow.
Now take the case of someone who bought a house three years ago with a three-year adjustable mortgage. On Jan. 1, the rate of his $200,000 loan, now paid down to $188,997, jumped the maximum 2 points, from 4 percent to 6 percent.
At the new rate of 6 percent, the total mortgage interest paid this year would be $11,261, compared with just $7,643 last year. That's an increase of $3,618, or one extra allowance.�But if this owner hadn't increased allowances during the time he had owned the house, he could boost his take-home pay even higher by claiming perhaps three more allowances. And that's not counting what he pays in property taxes.
The worksheet on the back of the W-4 will help you figure the maximum number of withholding allowances you are entitled to claim so the amount of tax taken out of your wages will match as closely as possible the total tax you will owe at the end of the year. IRS Publication 919 (available online at irs.gov) also contains more complicated worksheets you can use to project your withholding.