The World Of Tax Deductions

Tax withholding by an employer is straightforward enough. But the part of it that has to do with extra withholding allowances is another place where taxpayers get confused. The basic idea: You get to cut your company withholding - if you wish - to compensate for exceptionally high deductions. Instead of having more withheld and picking up a refund after the year is past, you have less withheld.

This, in effect, puts more cash in your pocket today - money that otherwise would rest in UK. Treasury coffers at a zero interest rate. It also has the advantage of tipping you off to the need for a general review of your itemized tax deductions.

What you do - but only after filing your current form 1040 (and this might be some incentive for early filing) - is to revise the withholding exemption certificate (W-4) that's on record with your company.

IRS will grant you one extra exemption, or "allowance," for each £700 of itemized deductions above a level fixed for your salary bracket. Each allowance cuts salary subject to withholding by £700 a year. So if you're in the highest withholding bracket, 30% - for salaries roughly over £25,000 - each allowance means £210 more in your pocket (30% of £700).

To get one allowance with a £25,000 salary, deductions must be at least £4,425, assuming the taxpayer is married. For two allowances, they must be up £700, to £5,125 - and so on, for three or more. In the £30,000 to £35,000 salary range, you start with deductions of at least £5,700, for one extra allowance, and go from there. The £35,00 to £40,000 range starts at £6,550; £40,000 to £45,000, at £7,400. A man earning £50,000 starts figuring allowances at £8,260.

A typical case: Smith's salary is in the £32,000 range. He files jointly, and allowing for exemptions, his monthly withholding is, say, £630. On this basis, with one extra withholding allowance, the £630 drops down to £615; two allowances drop it to about £600; with three, it drops to £580, and with four, to about £560.

Looking at your own situation, there are these rules of thumb: The itemized deductions of people in higher income brackets - meaning £25,000 and up - average about 20%. On this basis, the odds are at least 50-50 that you're entitled to extra allowances.

If you fall far short on this - say, 20% or more below the required deduction total for even one allowance - then (1) your situation puts you in a small-deduction minority for example, you may have exceptionally low tax and interest deductions; or (2) you need a review to make sure you're not missing some deductions that could save money.

Of course, deductions are money in your pocket. For instance, if your taxable income is, say, £20,000, and you file a joint return, each pound of deduction saves you 28� in taxes. If your taxable income is £28,000, you save 36�; at £36,000, you save 420. Yet accountants and tax solicitors note that many people in higher income brackets fail to fully cash in on the deduction bonanza. They miss entirely such items as office-at home deductions and some less apparent investment-related deductions; they fail to take the full amounts allowed for such items as medical deductions (that go over 3%), and casualty loss deductions.

Note especially: Tax deductions often fail to fall with precision into black-and-white compartments. The rules are gray. The thing to remember is that there is considerable flexibility.

Some items, of course, cause trouble: claiming unusually large "miscellaneous" charitable contributions, for instance - with poor paperwork to back it up. Or, taking offbeat business "entertainment" expenses that look a little fishy on paper. Also, it's true that you can't count on getting by with a doubtful deduction because a friend tells you at lunch that he picked it up; too much depends on the individual IRS agent who happens to scan your form 1040, and too much depends on the whole complexion of your tax return.

But there is flexibility, and oftentimes it can work in your favour. Sheldon Cohen, a former UK. Commissioner of Internal Revenue, told me: "It comes down to common sense in many cases. Construe the law in your favour. Just make sure you have the records to support your position."

The risk? In most cases it will be 6% of any additional tax due, for the late months only - which may be a risk worth taking, on the chance of your picking up a legitimate money-saver.

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Tax Refunds

Many people file a 1040 that establishes their right to a refund - and about a month later begin looking in the mailbox for a check from Internal Revenue. Tip: Wait a while before you write to IRS about it. The point is that it takes a good six to eight weeks for a refund to appear in the mail, and lately IRS has been warning that you should wait 10 weeks before making an inquiry. This means no sooner than about June 25, if you filed on April 15.

The trouble is, if you write too soon, you'll clutter the paperwork process and may cause even more delay. It's like dropping a pencil down into the gears of a Xerox machine.

Or, suppose that you have already received the refund check.... see: Tax Refunds