Should I change my W-4 to make ends meet?

John W. Schoen Senior producer • Profile • E-mail

With costs rising and paychecks flat, readers are looking for ways to make ends meet. Sandra is thinking about cutting back on withholding tax to give herself a raise. And Karen is trying to come up with a budget that lets her save for retirement.

Is it risky to go exempt for a couple of months on your payroll so that you can get all of your money (for) a week, just to make ends meet?
— Sandra, Address withheld

With real wages actually falling (after adjusting for inflation) and food and energy prices rising, a lot of paychecks just aren’t going far enough. If you need to stretch, it’s a lot easier to have less tax taken out of your weekly paycheck than it is to get an actual raise.

The problem is that you’re going to owe that tax in April — no matter how much you choose to have withheld. If you don’t expect a year-end bonus — or some other windfall to help you cover that tax bill next April — all you’re doing is postponing the pain.

If you undershoot too far, you may also end up getting hit with a penalty. The rule is you have to have enough withheld (or pay estimated tax) to cover at least 90 percent of the tax you owe. Like many rules, there’s an exception: If you get a raise this year, and the tax withheld is 100 percent of what you owed last year, you’re off the hook. (And there are special rules for farmers and fisherman, but we’ll leave that for another answer.)

On the other hand, if you got a refund this year (not the special tax rebate check — an actual refund from paying too much tax last year), you may be able to give yourself that withholding raise and still have enough to cover your tax bill in April.

The only way to know is to get a copy of IRS Form W-4 and fill out the worksheet on page 2. You’ll see at the top of the page, it asks for your itemized deductions, which is where you’ll fill in the amounts for qualified interest payments.

Unfortunately, like everything else about IRS math, there’s a fair amount of “voodoo economics” in the formulas used to calculate these withholdings. Even after filling out the worksheet, your final tax bill may end up over- or undershooting what you’ve had withheld.

If you earn a steady paycheck, you could also try estimating what you’ll have earned by the end of the year, see how much you’ll owe based on the 2007 tax rates, and then adjust your withholding accordingly. This is also a little risky: The new tables for 2008 will be different. But if your salary and deductions haven’t changed much, you’ll be close.

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